Archive for category: Commentary

July 18, 2011

With last week’s tumult in Italian markets, the European financial crisis has entered a new and far more dangerous phase. Where the crisis had been existential for small economies on the periphery of Europe but not systemically threatening to either the idea of European monetary union or to the functioning of the global financial system, it now threatens both European integration and the global recovery. Last week’s drama over bond auctions in Europe’s third leading economy should convince even the most hardened bureaucrat that the world can no longer let policy responses be shaped by dogma, bureaucratic agenda and expediency. It is to be hoped that European officials can engineer a decisive change of direction but if not, the world can no longer afford the deference that the International Monetary Fund and non-European G20 officials have shown European policymakers in the past 15 months.

Three realities must be recognised if there is to be a chance of success. First, the maintenance of systemic confidence is essential in a financial crisis. Teaching investors a lesson is a wish not a policy. US policymakers were applauded for about 12 hours for their willingness to let Lehman go bankrupt. The adverse consequences of the shattering effect that had on confidence are still being felt now. The European Central Bank is right in its concern that punishing creditors for the sake of teaching lessons or building political support is reckless in a system that depends on confidence. Those who let Lehman go believed that because time had passed since the Bear Stearns’ bail-out, the market had learnt lessons and so was prepared. In fact, the main lessons learnt were on how best to find the exits, and so uncontrolled bankruptcies had systemic consequences that far exceeded their expectations.

Second, no country can be expected to generate huge primary surpluses for long periods for the benefit of foreign creditors. Meeting debt burdens at rates currently charged by the official sector for credit – let alone the private sector – would involve burdens on Greece, Ireland and Portugal comparable to the reparations’ burdens Keynes warned about in The Economic Consequences of the Peace.

Third, whether or not a country is solvent depends not just on its debt burdens and its commitment to strong domestic policies, but on the broader economic context. Liquidity problems left unattended become confidence problems. Debtors who are credibly highly solvent at interest rates close to or below their nominal growth rates are likely to become insolvent at higher interest rates, putting further pressure on rates and exacerbating solvency worries in a vicious cycle. This has already happened in Greece, Portugal and Ireland, and is in danger of happening in Italy and Spain.

In short, the approach of lending more and more from the official sector to countries that cannot access the market at premium rates of interest is unsustainable. The debts incurred will in large part never be repaid, even as their size discourages private capital flows and indeed any growth-creating initiative. Assertions that the most indebted countries can service their debts in full at current interest rates only undermine the credibility of policymakers when they go on to assert that the fundamentals are relatively sound in Spain and Italy. Further lending at premium interest rates only increases the scale of the necessary restructuring. It is reasonable to argue that the recognition of debt unsustainability in Greece has been excessively deferred. It is not reasonable to argue that Greek reprofiling or restructuring alone will address a general crisis of confidence.

A fundamental shift of tack is required, towards an approach focused on avoiding systemic risk, restarting growth and restoring arithmetic credibility rather than simply staving off disaster. The twin realities that Greece, Italy and Ireland need debt relief and that the creditors have only limited capacity to take immediate losses, mean that all approaches require increased efforts from the European centre. Fortunately, the likely consequence of doing more upfront is a lower cost in the long run. The details are less relevant than having an appropriate approach overall, aligned with EU political realities. But some elements are crucial to any viable strategy.

European authorities must restate their commitment to solidarity as embodied in a common currency and recognise that the failure of any European economy is unacceptable. If they can find the political will, the technicalities of a policy response are not that difficult. But it should include these further commitments.

First, for programme countries, interest rates on debt to the official sector should be reduced to a European borrowing rate, defined as the rate at which common European entitities backed with joint and several liability by all the countries of Europe can borrow. A default to the official sector will not be tolerated, so there is no reason to charge a needless risk premium that puts the whole enterprise at risk.

Second, countries whose borrowing rate exceeds some threshold – perhaps 200 basis points over the lowest national borrowing rate in the euro system – should be exempted from contributing to bail-out funds. The last thing the marginal need is to be pulled down by the weak.

Third, there must be a clear commitment that, whatever else happens, no big financial institution in any country will be allowed to fail. The most serious financial breakdowns – in Indonesia in 1997, Russia in 1998, and the US in 2008 – came when authorities allowed doubt over the basic functioning of the financial system. This responsibility should rest with the ECB, with the requisite political support.

Fourth, countries judged to be pursuing sound policies will be permitted to buy EU guarantees on new debt issuances at a reasonable price, payable on a deferred basis.

These measures would do much to contain the storm. They would lower payments for debtor nations, protect states at risk from participation in rescue efforts or from shortfalls in market confidence, and ensure the ECB could continue backstopping the stability of European banks.

This leaves the question of what is to be done with sovereign private debt. Creditors gain nothing from breakdown. Some will want to sell out of their exposures at prices marginally above their current market value. Others, who are still regarding sovereign European debts as worth par, should be given appropriate, reduced interest rate longer maturity options. Debt repurchases are a possibility if the private sector accepts sufficiently large present-value debt reductions. But any approach should be judged on the sustainability of programme country debt repayments.

Much of this will seem unrealistic given the terms of Europe’s debate. It seemed highly unrealistic even 10 days ago that Italy’s solvency would come into substantial doubt. The alternative to forthright action today is much more expensive action – to much less benefit – in the not too distant future. The next few weeks may be the most important in the history of the EU.

The writer is Charles W. Eliot university professor and president emeritus at Harvard University. He was Treasury secretary under President Bill Clinton.

Copyright The Financial Times Limited 2012.

September 18, 2011

In his celebrated essay “The Quagmire Myth and the Stalemate Machine”, published in 1972, Daniel Ellsberg drew out the lesson regarding the Vietnam war that came out of the 8,000 pages of the Pentagon Papers, which he had secretly copied a few years earlier. It was simply this: policymakers acted without illusion. At every juncture they made the minimum commitments necessary to avoid imminent disaster – offering optimistic rhetoric, but never taking the steps that even they believed could offer the prospect of decisive victory. They were tragically caught in a kind of no-man’s-land – unable to reverse a course to which they had committed so much, but also unable to generate the political will to take forward steps that gave any realistic prospect of success. Ultimately, after years of needless suffering, their policy collapsed around them.

Much the same process has played out in Europe over the past two years. At every stage of this process, from the first signs of trouble in Greece, to the spread of problems to Portugal and Ireland, to the recognition of Greece’s inability to pay its debts in full, to the rise of debt spreads in Spain and Italy, the authorities have played out the stalemate machine. They have done just enough beyond euro-orthodoxy to avoid an imminent collapse, but never enough to establish a sound foundation for a resumption of confidence. Perhaps inevitably, the gaps between emergency summits grow shorter and shorter.

The process has taken its toll on policymakers’ credibility. As I warned European friends quite some time ago, authorities who assert in the face of all evidence that Greece can service on time 100 per cent of its debts will have little credibility when they later assert that the fundamentals are sound in Spain and Italy, even if their view on the latter point is a reasonable one. After the spectacle of European bank stress tests that treat assets where credit default swaps exceed 500 basis points as riskless, how can markets do otherwise than to ignore regulators’ assertions about the solvency of certain key financial institutions?

A continuation of the grudging incrementalism of the past two years now risks catastrophe. What was a task of defining the parameters of “too big to fail” has become the challenge of figuring out what to do when important insolvent debtors are too large to save. There are many differences between the environment today and the environment in the autumn of 2008, or indeed at any other historical moment. But any student of recent financial history should know that breakdowns that seemed inconceivable at one moment can seem inevitable at the next.

To her very great credit Christine Lagarde, the new managing director of the International Monetary Fund, has already pointed up the three principles that any approach to Europe’s financial problems must respect. First, Europe must work backwards from a vision of where its monetary system will be several years hence. The reality is that Europe’s politicians have for the past decade dismissed the widespread view among experienced monetary economists that multiple sovereigns with independent budgeting and banking regulation will over time place unsustainable strains on a common currency. The European Monetary Union has been a classic case of the late economist Rudiger Dornbusch’s dictum: “In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.” So it has been with the build-up of pressures on the eurozone system.

There can be no return to the pre-crisis status quo. It is now clear that market discipline within monetary union is insufficiently potent and credible to assure sound finance. It is equally clear that the risk of self-fulfilling confidence crises becomes substantial when banks and sovereigns have no access to lender of last resort financing. The responsibilities of the ECB, national financial and regulatory authorities and EU officials can be defined in different ways. But there must now be simultaneously an increase in the central financial commitment to the financial stability of member states, and a reduction in their financial autonomy, if the common currency is to survive.

Second, Ms Lagarde is right to point out serious issues of inadequate capital in European banks. Taking even relatively optimistic views about sovereign debt and growth prospects, European banks are in at least as problematic a condition as American banks were in the summer of 2008. Unfortunately, in many cases they are far larger relative to their national economies. Now is the time for realistic stress testing, and then resorting to private capital markets if possible, and to public capital infusions if necessary. With delay, private capital markets will close completely and nervous managements will rein in the provision of credit just when credit contraction is most likely to damage real economic prospects.

Third, like her predecessor, Ms. Lagarde has broken with IMF orthodoxy in noting that expansionary policies are necessary in the face of substantial economic slack. The oxymoronic doctrine of expansionary fiscal contraction is being discredited with every passing month. Europe needs a growth strategy. Yet almost everywhere, and certainly in the most indebted countries, binding commitments to eventual deficit reductions are a necessity. And in some places credibility has been lost to the point where immediate actions are needed. But Europe can handle its debts and contribute to a stronger global economy only if it grows. This will require both aggregate fiscal and monetary expansion.

This last point is an essential lesson of recent American experience. Even though credit spreads and equity values had normalised by the end of 2009, and the financial system was again functioning reasonably normally a year after the 2008 panic, lack of demand has continued to constrain growth. While any single household or nation can improve its balance sheet by saving more and spending less, the effort by all to cut back means reduced incomes and ultimately less saving for all. Germany, in particular, needs to recognise that if other European nations are going to borrow less then it will be able to lend less, and that as a matter of arithmetic this will mean a smaller trade surplus.

The world’s finance ministers and central bank governors will gather in Washington next weekend for their annual meetings. The meetings will have been a failure if a clearer way forward for Europe does not emerge. Remarkably, the European authorities that drove Ms Lagarde’s selection just three months ago have rejected important components of her analysis. In normal circumstances comity would require deference by others to European authorities on the resolution of European problems. Now, when these problems have the potential to disrupt growth around the world, all nations have an obligation to insist that Europe find a viable way forward. Failure would be yet another example of what Churchill called “want of foresight, unwillingness to act when action would be simple and effective, lack of clear thinking, confusion of counsel until the emergency comes, until self- preservation strikes its jarring gong – these are features which constitute the endless repetition of history”.

The writer is Charles W. Eliot University Professor at Harvard.

Copyright The Financial Times Limited 2012.

August 2, 2011

At last Washington has reached a deal that raises the debt limit and averts a default that would have been a national embarrassment and an economic and geopolitical catastrophe. The forces shaping the deal and the deal itself are multifaceted and so also is the right reaction to it. Mine has a number of elements.

The first is relief. There will be no first default in US history; no economy-damaging short-run austerity; no attack on the nation’s core social protection programmes or universal healthcare; and no repeat of the past month’s shabby spectacle for at least 15 months. All of this was in doubt even a week ago, as congressional intransigence threatened to make the problem of raising the limit insoluble.

The Hippocratic Oath applies in economics as well as medicine, and so it is no small thing for the administration to have struck an agreement that does no immediate harm. It may well be that no better agreement was achievable, given the dynamics in Congress.

But next comes cynicism. An objective observer would now predict larger US budget deficits than a few months ago. The economic forecast has deteriorated, and it is reasonable to estimate even a half a per cent reduction in growth, averaged over 10 years, adds more than a trillion dollars to the national debt by 2021.

Despite claims of spending reductions of about $1,000bn, the agreement will also have little impact on spending during the next decade. The deal confirms the low spending levels already negotiated for 2011 and 2012, and caps 2013 spending where most would have expected this Congress to end up.

Beyond that, the outcomes are anyone’s guess. The reality is that Congress approves discretionary spending annually, and the current Congress cannot effectively constrain future actions. True, there are caps and sequester threats present in the debt limit legislation, but these are virtually certain to be reformulated in 2013. The reality was, and still is, that discretionary spending will reflect the will of future congresses.

Remarkably for a matter so consequential, the agreement the super committee will seek to reduce the deficit by $1,500bn comes without any agreement on what the baseline is from which that figure is to be subtracted. Does the baseline include the Bush tax cuts? Does it exclude tax extenders, or the annual fix on the alternative minimum tax? These and other questions are unresolved.

Such baselines arguments are mind numbing, but highly consequential. If a baseline following current policy is adopted, for instance, probably in an effort to make deficit reduction easier, it would treat the non-extension of the Bush-era high income tax cuts as a $1,000bn tax increase – hardly a likely outcome given the composition of the proposed super committee.

Economic anxiety should be our final reaction. America’s current problem is much more a jobs and growth deficit than an excessive budget deficit. This is confirmed by the fact that a single bad economic statistic more than wiped out all the stock market gains from the avoidance of default, and the fact that bond yields reached new lows at the moment of maximum apparent danger on the debt limit.

On the current policy path, which involves a substantial withdrawal of fiscal stimulus when the payroll tax cuts expire at the end of the year, it would be surprising if growth was rapid enough even to bring unemployment down to 8.5 per cent by the end of 2012. With growth at less than 1 per cent in the first half of the year, the economy is now at stall speed with the prospects of adverse shocks from a European financial crisis that is decidedly not under control, spikes in oil prices and confidence declines on the part of businesses and households. Based on the flow of statistics, the odds of the economy going back into recession are at least one in three – if nothing new is done to raise demand and spur growth.

If these judgments are close to correct, relief will soon give way to alarm about the US’s economic and fiscal future. Among all the machinations ahead, two issues stand out. First, the single largest and easiest method of deficit reduction is the non-extension of the Bush high-income tax cuts. The president should make clear that he will not accept their extension on any terms. That, along with modest entitlement reform, will be sufficient to hit current deficit reduction targets. Second, it is essential the payroll tax cut be extended and further measures, such as infrastructure maintenance and unemployment insurance extension, be taken to spur demand. If so, there is still time to confirm Churchill’s maxim that the US always does the right thing after exhausting all the alternatives.

The writer is Charles W. Eliot university professor and president emeritus at Harvard University. He was Treasury secretary under President Bill Clinton.

Copyright The Financial Times Limited 2012.

November 2, 2011

Leaders of the Group of 20 big industrial and developing countries first convened almost three years ago to address the financial crisis. As now, there were deep doubts about the financial fundamentals of a major economy. As now, authorities were struggling to bring Main Street the financial stability it needed, without going too far beyond what it wanted. As now, the immediate task was to contain financial panic and the deeper challenge was to lay a foundation for renewed and inclusive prosperity.

The depression that looked possible then has been avoided but the outlook is hardly satisfactory. What can be learnt from the past three years as the G20 gathers in Cannes? The world’s leaders, especially the Europeans, will ignore the following lessons at their peril.

First, programme announcements that are vague and try to purchase stability on the cheap are more likely to exacerbate problems than to resolve them. Examples include the abortive super-SIV plan of former US Treasury secretary Hank Paulson; the first financial crisis resolution plan presented by his successor, Tim Geithner; and Europe’s successive attempts to resolve the eurozone’s crises. Where policy has succeeded – as with the original Tarp in the US, China’s stimulus measures or Switzerland’s recent effort to stabilise its currency – it has been based on clear actions exceeding the minimum necessary to stabilise the situation. This implies that only specific announcements going far beyond existing proposals will lower European spreads to the point where countries such as Italy and Spain can be seen as solvent.

Second, dubious assertions by policymakers end up undermining confidence. Like the 13th chime of a clock, policymakers who deny the obvious or claim to know the unknowable call into question all that they say. Examples include regulators’ assertions in 2008 that large banks had enough capital, claims that the US was enjoying a summer of recovery, and recent claims that Greece is not in default. Why should any investor rely on any default insurance from European authorities who heatedly deny that Greece is in default? The sooner it is recognised that the ideas advanced so far for leveraging the eurozone’s bail-out fund are incoherent, the sooner the crisis may be resolved.

Third, containing systemic financial risk is not enough to restore growth. US credit markets had largely returned to normal by the end of 2009, but because of weak demand, growth has not been sufficient to reduce unemployment. Even if Europe restores its finances, it is hard to see what will drive growth in countries pursuing austerity programmes that will cut incomes and demand. A faltering European economy will cut demand for exports and, if banks achieve higher capital ratios by shrinking, the supply of credit will contract.

Fourth, the greatest risk of sovereign credit crises comes not from profligacy but slow growth and deflation. Four years ago Spain and Ireland were seen as models of fiscal rectitude. Their problems come from a collapsing economy and financial system. For very indebted countries, a prolonged period when the rate of interest on debt far exceeds the nominal growth rate makes reducing debt to GDP ratios all but impossible. Analyses of austerity measures consistently overestimate their efficacy by neglecting their adverse effects on economic growth and inflation and hence on future tax receipts. If reasonable growth in the global economy is restored, deficit problems will be manageable. Without growth, it is likely to be impossible to ease debt burdens.

Fifth, the doctrine of expansionary fiscal contraction is an oxymoron in the current context. It is often said that determined efforts to cut deficits will boost growth. This is sometimes true. Canada in the 1990s – which started with very high interest rates, had a rapidly growing large neighbour, and let its currency depreciate – is a classic example. Now, safe interest rates are already very low; reliance on fast-growing neighbours is not viable unless big surplus countries such as China and Germany change policy; and eurozone deficit countries cannot depreciate against their main trading partners. Instead, as Britain is now demonstrating, fiscal contraction leads to economic contraction. This situation is made worse if, as in Europe at present, the central bank does not act to offset the adverse impact of austerity on demand.

These are hard lessons to heed. It would be much easier for the G20 to celebrate the recent European agreement, despite market turmoil, and vow to maintain the current global trajectory with lip service to adjustment in surplus countries. This would be a disaster. For the final lesson of the crisis is that confidence and complacency are self-denying prophecies. Only if policymakers feel the alarm appropriate to dangers as great as any the world economy has faced over the past 30 years will they take the necessary action.

The writer is a former US Treasury secretary.

Copyright The Financial Times Limited 2012.

January 8, 2012

It would have been almost unimaginable five years ago that the Financial Times would convene a series of articles on “Capitalism in Crisis”. That it has done so is a reflection both of sour public opinion and distressing results on the ground in much of the industrial world.

Americans have traditionally been the most enthusiastic champions of capitalism. Yet, a recent public opinion survey found that among the US population as a whole 50 per cent had a positive opinion of capitalism while 40 per cent did not. The disillusionment was particularly marked among young people aged 18-29, African Americans and Hispanics, those with incomes under $30,000 and self-described Democrats.

Three elections in a row in the US have been, by recent standards, bloodbaths for incumbents. In 2006 and 2008 the left did well; in 2010 the right won comprehensively. With the rise of the Tea Party on the right and the Occupy movement on the left, this suggests that far more is up for grabs than usual in this election year.

So how justified is disillusionment with market capitalism? This depends on the answer to two critical questions. Do today’s problems inhere in the present form of market capitalism or are they subject to more direct solution? Are there imaginable better alternatives?

The spread of stagnation and abnormal unemployment from Japan to the rest of the industrialised world does raise doubts about capitalism’s efficacy as a promoter of employment and rising living standards for a broad middle class. The problem is genuine. Few would confidently bet that the US or Europe will see a return to full employment, as previously defined, within the next five years. The economies of both are likely to be demand constrained for a long time.

But does this reflect an inherent flaw in capitalism or, as Keynes suggested, a “magneto” problem – like the failure of a car alternator – that can be addressed with proper fiscal and monetary policies and which will not benefit from large scale structural measures. I believe the evidence overwhelmingly supports the latter. Efforts to reform capitalism are more likely to divert from the steps needed to promote demand, than to contribute to putting people back to work. I suspect that if and when macro-economic policies are appropriately adjusted, much of the contemporary concern will fade away.

That said, serious questions about the fairness of capitalism are being raised. These are driven by sharp increases in unemployment beyond the business cycle – one in six of American men between 25 and 54 is likely to be out of work even after the economy recovers – combined with dramatic rises in the share of income going to the top 1 per cent (and even the top 0.01 per cent) of the population and declining social mobility. The problem is real and profound and seems very unlikely to correct itself untended. Unlike cyclical concerns there is no obvious solution at hand. Indeed, since even Chinese manufacturing employment appears well below the level of 15 years ago it suggests that the roots of the problem lie deep within the evolution of technology.

The agricultural economy gave way to the industrial one because progress enabled demands for food to be met by only a small fraction of the population freeing large numbers of people to work elsewhere. The same process is now under way with respect to manufacturing and a range of services, reducing employment prospects for most citizens. At the same time, just as in the early days of the industrial era the combination of substantial dislocations and greater ability to produce at scale is enabling a lucky few to acquire great fortunes.

The nature of the transformation is highlighted by the 50 fold change in the relative price of a television set of a constant quality and a day in a hospital over the last generation. While it is often observed that wages for median workers have stagnated, this obscures an important aspect of what is occurring. Measured via items such as appliances or clothing or telephone services, where productivity growth has been rapid, wages have actually risen rapidly over the last generation. The problem is that they have stagnated or fallen measured relative to the price of food, housing, healthcare, energy and education.

As fewer people are needed to meet the population’s demand for goods like appliances and clothing it is natural that more people work in producing goods like healthcare and education where outcomes are manifestly unsatisfactory. Indeed as the economist Michael Spence has documented, a process of this kind is under way: essentially all US employment growth over the last generation has come in non-traded goods.

The difficulty is that in many of these areas the traditional case for market capitalism is weaker. It is surely not an accident that in almost every society the production of healthcare and education is much more involved with the public sector than is the case with the production of manufactured goods. There is an imperative to move workers from activities like steelmaking to activities like taking care of the aged. At the same time there is the imperative of shrinking or least slowing the growth of the public sector.

This brings us to the charge that the governments of industrial market capitalist societies are bankrupt. Even as market outcomes seem increasingly unsatisfactory, budget pressures have constrained the ability of the public sector to respond. How and when – not whether – basic programmes of social protection will be cut back is now back on the table. The basic solvency of too many capitalist states seems in question.

Again the problems are very real. While I believe more than most that the US government will be able to borrow on very attractive terms for a long time, if – as I fear – private borrowing remains depressed, there is no denying that the current path of planned spending and planned revenue collection are inconsistent. And Europe is teaching us that markets can take significant fiscal problems and make them catastrophic by becoming too alarmed too rapidly.

At one level the answer here is simply to insist on more political will and courage. But at a deeper level, citizens of the industrial world who believe that they live in progressive societies are right to wonder why increasingly affluent societies need to roll back levels of social protection. Paradoxically, the answer lies in the very success of capitalism which has made the opportunity-cost of an individual teaching or nursing or administering that much more expensive.

When outcomes are unsatisfactory, as they surely are at present, there is always a debate between those who believe that the current course needs to be pursued with increased vigour and those who argue for a radical change in direction. That debate is somewhat beside the point in the case of market capitalism.

Where it has been applied it has been an enormous success. The challenge for the next generation is that success will increasingly be taken for granted and indeed will become an increasing source of frustration, for in these pinched times, its success cannot be matched outside the market’s natural domain. It is not so much the most capitalist parts of the contemporary economy but the least – those concerned with health education and social protection that are in most need of reinvention.

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

Copyright The Financial Times Limited 2012.

April 26, 2012

Political arithmetic is invariably suspect and one should always examine carefully the claims of those seeking votes. However, just as one should look at audited and unaudited financials very differently when deciding whether to invest in a company, smart observers have learnt to distinguish between the claims of political candidates and their advisers on one hand, and proposals evaluated by non-political scorekeepers such as the Congressional Budget Office on the other.

This principle has never been better illustrated than by the “budget analysis” put forward by Glenn Hubbard, an economic adviser, to Mitt Romney, the presumptive Republican nominee. In an op-ed published on Wednesday in the Wall Street Journal, he constructs a budget plan he imagines President Barack Obama might one day propose, engages in a set of his own extrapolations, then makes several assertions about it. He does not discuss Mr Obama’s actual plan or how it has been evaluated by the CBO. Nor does he defend the claims Mr Romney has made regarding his own fiscal plans.

Mr Obama has put forward a plan that would cut deficits by more than $4tn over the decade. It starts by making tough decisions on spending, bringing discretionary spending to its lowest levels since the 1960s. It includes $2.50 in spending cuts for every $1 in additional revenue. It also asks everyone to pay their fair share of taxes, repealing the tax cuts made by President George W. Bush for families making more than $250,000 and closing loopholes and shelters such as preferences for private jets, hedge fund managers, and offshore investments.

The independent CBO confirms that the plan would stabilise the debt as a share of the economy, returning us to a sustainable fiscal path. It would do that while allowing increased investments in education, research and infrastructure that are critical to stronger, shared economic growth in the years to come. By focusing on building a robust economy for the future, it expands the tax base and reduces pressures for future tax increases.

But rather than criticise this approach, Mr Hubbard ignores it – and instead chooses to invent a set of assumptions that bear no relationship to the president’s actual policies. His figures are not explained, but they apparently arbitrarily assume that the president must raise taxes to pay for spending above a level of Mr Hubbard’s choosing. This hypothetical exercise bears no resemblance to the president’s policies.

Rather than filling imaginary gaps in the president’s budget, which has been spelt out in sufficient detail to permit evaluation by independent experts, Mr Hubbard should perhaps fill in some of the many gaps in the current presentations of Mr Romney’s economic plans.

He could start with the tax plan. The Romney campaign has been very clear about what he is promising: $5tn in tax cuts on top of extending the Bush tax cuts, with those benefits heavily weighted towards the wealthiest taxpayers.

Mr Romney claims to pay for this plan by ending tax shelters, principally for the wealthy, but he has not specified a single tax break that he would close. I have been party for many years to searches for “high income tax shelters” that can feasibly be closed. There is no reputable expert in either political party who finds it remotely credible that there is anything approaching $5tn in revenues to be generated from this source.

Mr Romney has also proposed a huge increase in defence outlays, even while he says he will cut spending deeply enough to balance the budget. He has clearly explained why he will not tell voters which cuts he would make: because in past campaigns, he found that disclosing his planned budget cuts was politically damaging.

We have seen this narrative before. When Bill Clinton left office in January 2001, our country was paying down its debt on a substantial scale. I was privileged as secretary of the Treasury to be buying back federal debt. George W. Bush campaigned on a programme of tax cuts supported by economic advisers not subject to the rigours of official budget score-keeping. The results in terms of trillions of dollars of budget deficits speak for themselves.

This is a very consequential election. As we continue to recover from the largest economic crisis in generations, we still need to strengthen the job market, address large fiscal challenges and build an economy based on sustainable, shared economic growth. Voters should have a chance to choose between clear alternatives. Mr Obama has laid out a multiyear budget embodying his vision for the future, and it has been evaluated by independent experts. It is time for Mr Romney to do the same.

The writer was director of the national economic council under Barack Obama and is Charles W. Eliot professor at Harvard University.

Copyright The Financial Times Limited 2012.

June 18, 2012

Once again good news has had a half-life in the markets of less than 24 hours. Just as news of Spain’s bank bailout rallied markets and sentiment for only a few hours, a Greek election outcome as good as could have been hoped did not buoy markets for even a day. There could be no clearer evidence that the strategy of vowing that the European system will hold together, doing the minimum to address each crisis as it comes and promising to build a system that is sound in the long run has run its course.

Nor is the Group of 20 leading economies, whose leaders conclude their meeting today, likely to change anything soon. Europe’s troubled economies will demand more emphasis on growth, lower interest rates on their official debts and more transfers. The Germans will show sympathy with the aim of reform but will insist that financial integration coincide with political integration. The rest of the world will express exasperation with Europe’s failures and demand more be done. Officials blessed with more diplomatic than economic insight or courage will produce a communiqué expressing a measure of satisfaction with the steps under way, recognising the need to do more and looking forward to continued dialogue. The only good thing is that expectations are so low this will barely disappoint markets.

The truth is that Europe’s debtors and creditors are both right. The borrowers are right that austerity and internal devaluation have never been a successful growth strategy, certainly not when major trading partners are stagnating. In the few cases where fiscal consolidations have preceded growth, they have either involved stagnation relative to previous levels of income (as in Ireland and the Baltics) or buoyant demand associated with surging exports, increasing competitiveness and low borrowing costs (many euro members in the early years). The borrowers are also right to claim that even a previously healthy economy will quickly become very sick if forced to operate for several years with interest rates far above growth rates, as is the case across southern Europe. And experience clearly shows that structural reform is always harder when an economy is contracting and there is no sector to absorb those displaced by reform.

Those wary of institutionalising financial integration without serious political integration are right as well. In a sound system, those with deep pockets who act either as borrowers or as guarantors must have control over borrowing decisions. A system where I borrow and you repay is a prescription for profligacy. This is why there is now so much discussion of eurozone bonds and Europe-wide deposit insurance being linked with much deeper political integration.

But there are two problems lying behind the soft references to greater integration. The first is the question of who really has control. If decisions are genuinely to be made at eurozone level, it is far from clear that there is any majority or even plurality support for responsible policies. If the idea is that the eurozone will be modelled on the European Central Bank – a European facade behind which Teutonic policies are pushed – it is far from clear that this will or should be acceptable across the continent.

The second problem is the scale of the transfers that could be involved. A good guess would be that during the US savings and loans crisis, the American south-west received a transfer from the rest of the country equal to at least 20 per cent of its gross domestic product. Is there a real will to commit to potential transfers of this scale in Europe? Maybe all of this can be resolved but it will surely not happen quickly.

Not all problems can be solved. It is not certain that the full repayment of all currently contracted sovereign debts, sustainable growth for all, and the eurozone retaining all its current members will prove feasible. The private sector is making clear that it recognises this painful reality. Official sector planning needs to recognise it as well. Outside Europe, even as leaders hope for the best they need to plan for the worst, ensuring adequate liquidity and demand in their economies even if Europe’s situation deteriorates rapidly. The fortification of the International Monetary Fund is a start but policy makers need also to consider national policies, trade, finance and social safety nets.

But a eurozone collapse would be a disaster that might define our era. Its prospect must focus the minds of all at the G20 summit on action. Non-Europeans must persuade Europeans that the rules change when the stakes rise. The ECB’s credibility will mean little if there is no longer a common currency.

Setting the right precedent seemed far more important 24 hours before Lehman’s collapse than 24 hours after it. Now is the time for radical cuts in the rates charged by official creditors to European sovereigns; for a willingness to subordinate official debts; and for expansionary monetary policies in Europe that prevent deflation and encourage the growth that can create jobs and reduce debts. Only if the system is preserved can its future be debated.

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

Copyright The Financial Times Limited 2012.

August 19, 2012

With the selection of Paul Ryan as the Republican vice-presidential candidate, it is clear both political parties agree that the central issue in the presidential election will be the scale and scope of government involvement in the US economy. There will be disagreement over what constituted “normal” levels of spending in the past and indeed over what constitutes “spending”. But there is a widespread view in both parties that it is feasible and desirable that in the future the federal government will be no larger as a share of the overall economy than it has been historically.

Unfortunately, this aspiration is unlikely to be achieved. Even preserving the amount of government functions the US had before the financial crisis will require substantial increases in the share of the economy devoted to the public sector. This is the case for several structural reasons.

First, demographic change will greatly expand federal outlays unless politicians decide to degrade the level of protection traditionally provided to the elderly. Between Social Security, Medicare and Medicaid and other smaller programmes, about 32 per cent of the US federal budget, or about 7.7 per cent of gross domestic product, is devoted to supporting those aged over 65. The ratio of this age group to those of working age will increase from 1:4.6 to 1:2.7 over the next generation, implying a rise in federal spending of 5.6 percentage points of GDP, if no other adjustments are made. True, as Americans’ health and life expectancy improve, it may be appropriate to revise upward the assumed retirement age. However, it will be unlikely to counteract the expected 34 per cent increase over the next generation in the share of the population who will be within 15 years of estimated life expectancy.

Second, the accumulation of more debt and a return to normal interest rates will raise the share of federal spending devoted to interest payments. In 2007, before the financial crisis, federal debt held by the public was equivalent to 36.3 per cent of GDP. On a very optimistic view, where recommendations such as those of the National Commission on Fiscal Responsibility and Reform (the Bowles-Simpson commission) are implemented, net debt held by the public will nearly double to 65 per cent of GDP by 2020. This implies that the federal government’s outlays to service its debt will rise from 1.7 per cent of GDP in 2007 to 3.2 per cent of GDP in 2020.

Third, increases in the price of what the federal government buys relative to what the private sector buys will inevitably increase the cost of state involvement in the economy. Since the early 1980s the price of hospital care and higher education has risen fivefold relative to the price of cars and clothing and more than 100-fold relative to the price of televisions. Similarly, the complexity and hence the cost of everything from cutting-edge scientific research to regulating banks rises faster than overall inflation. These trends reflect long-running trends in globalisation and technology. They imply that if government is to continue providing the same level of these services, government spending as a share of the economy has to rise, by at least 3 per cent of GDP.

Fourth, several methods that have been used to repress the deficit will soon be found to be unsustainable. Federal pension liabilities and the deferred maintenance of federal infrastructure are two examples.

Meanwhile, there is a steady decline in the fraction of tax returns that are audited and there is evidence of growing tax non-compliance. Both are a reflection of unsustainable cuts in spending. And on almost any reasonable view of the state’s responsibility, large increases in inequality such as those we have observed in recent years should call forth increased government activity. All of these factors suggest the likelihood of increased pressure on federal budgets over the years ahead.

There are ways in which federal spending can be reduced. Defence spending, which now represents 4.7 per cent of GDP (its average level over the past 40 years) could be reduced significantly. On the other hand, the fact that in a dangerous world our military is badly stretched by sustained deployments that are far smaller than even the first Iraq war suggests there is little ground for confidence that the Pentagon budget will be cut dramatically.

In some areas technology could greatly reduce government costs but it is important to recognise that by far the largest parts of the federal budget involve cash or in-kind transfers. These parts are far less susceptible to productivity-enhancing technologies than areas that involve the production of goods or services. There is scope for the elimination of outdated or duplicate programmes but efforts to identify waste, fraud and abuse invariably come up with only negligible savings.

For the next three months the US will debate the merits of growing versus shrinking government. But for the next three decades it will confront the reality that major structural changes in the economy will compel an increase in the public sector’s fraction of the total economy unless there is a substantial scaling down in the functions that the federal government has long performed. How government can best prepare for the pressures that will come, and how greater revenues can be mobilised without damaging the economy, are the great economic questions for the next generation.

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

Copyright The Financial Times Limited 2012.

 Lawrence H. Summers Remarks, March 30, 2011

I thought what I would do, actually, is something a little different than maybe some of your speakers have done. I’m going to be very brief, and I’m happy to talk about any economic or public policy question, or question about higher education that interests anybody here. But what I thought I would do is just offer a few observations on things I have learned since the time when I was a young global leader in this program about 20 years ago, things I’ve learned from things I’ve done right, and things I’ve learned from things I’ve done wrong.

Observation one. Only a very few things will matter. One of the features of aggressive, ambitious personalities – and that’s probably what makes most of you part of this group – is that you want to touch as many things as you can. You want to have as broad an influence as you can, and you want to stick your finger in many, many different pies. In fact, it ends up being that very few things matter importantly. I served as the international affairs person for the Treasury throughout President Clinton’s first term. The only thing that really, in the end, was hugely important was that we bailed out Mexico on a large scale, at a moment when that was a historically implausible thing to do, got the money back, and rescued Mexico, so it was a substantial success.¹

But all of the important decisions were taken in a six-week period. But that six week period was defining of my multi-year experience. That doesn’t mean that I could have afforded to have done nothing during the other time, but it does mean that, at that moment, all my mental energy was usefully devoted to that problem, that that needed to be a priority, that completing that task successfully was one that is of enormous importance.

It’s an observation that scholars of marketing have made about people who shop, that people will work just as hard to save 10% when they’re purchasing a tennis racket as they will to save 5% when they’re purchasing a car, even though 5% of a car is infinitely more important than 10% of a tennis racket, in financial terms.² Figuring out what is really important, and what is ephemeral, is one of the most important things that one can do to try to succeed.

And a very good test in life to use towards that objective is to project yourself forward into the future, and to ask, will I care about this a year from now? Will I care about this three years from now? Will I care about this five years from now? And it provides a very useful perspective. Most of the time, it causes you to think that whatever you’re aggravated about at the moment isn’t very important. Every once in a while, when there’s a once-in-a-lifetime position that’s come up, that you thought you had a chance of getting and you don’t get, this type of perspective can make you feel worse rather than better. But it’s a step towards thinking more clearly, and I think it’s something that is very, very important.

The second observation that I’d make is that a pretty substantial fraction of the time, the most important decisions that you make will be the negative decisions that you make. There were several moments during the Clinton administration, when I had been there for awhile in a sub-cabinet position, when I had been through the Mexican thing, which was enormously important and exciting, or it felt so to me, when nothing of comparable importance and excitement was under way, when I was offered very attractive positions, and was sorely tempted to take them. But on balance, I felt that while I couldn’t see exactly what was going to happen, the opportunities that were likely to come with senior government service that were not likely to come again – was, on balance, the better thing.

I would not have had the opportunities I’ve had to be Secretary of the Treasury, to serve as Harvard’s President, serve as the President’s Chief Economic Advisor, if I had accepted the positions for which I was sorely tempted to take at those points during the Clinton administration. Most of the people in this room will have a lot of opportunities to do a lot of different things. It is easy to have opportunities, be excited, and say yes. It is actually harder to say no to tempting opportunities, and it is a very important part of having succeeded.

One of the things you will be struck by, if you actually study the lifetime careers of successful people, is that while they are summarized in little descriptions, if you actually look hard at their careers, there are years and years when nothing actually hugely important and consequential, that somebody would mention in an introduction or an obituary, came up. And yet, those were part of the career, and those were part of preparing for the career. And so, particularly as you go from being a young global leader to being a global leader, you have to get used to the fact that not every year’s going to be the most exciting year of your career. It can’t be that way, and not every year is going to be more exciting than the last year. And sometimes what you have to do is ride along with where you are, and it’s something that people often have difficulty doing. But it is actually integral to success.

I would say a third thing that I think is enormously important is – and is also part of the transition from being a young global leader to being a global leader – is paying attention to those who are more junior to you. You are at the stage in your career where the most important relationships you have had have been with those who are either parallel to you or those who are senior to you. Over time, that situation will change and evolve. I think of all the influence that I’ve been able to have, not an insubstantial portion of it has been through people who I was able to work with and mentor who were younger than me, people like Tim Geithner, the current Treasury Secretary, people like Sheryl Sandberg, who I think is one of your number, who is running Facebook, and others.

You are missing a chance to have important influence on the world, and you are missing a chance to secure the kinds of legacy for yourself that you want, if you are not substantially investing in the careers of people who are following behind you, as well as trying to do a very good job for those who are older and more senior than yourself.

Fourth is the last one. Know what you think, and know what you want to do, but have a clear-eyed view of it. My observation in life is that people who maximize their potential, and maximize what they’re able to contribute, are able to have a clear idea of what they want to do. They know what they think about whatever issue they’re working on, they know what the vision is for whatever product they want to create, they know what policy they want to advocate. That’s one part of it. And the other part of it is if you ask them, what are the three biggest problems with the product they’re trying to create, or what are the three biggest problems with the policy that you’re trying to advocate, they’re able to give you a strong and persuasive answer to the question. And I have learned over time that whenever anybody advises me to do X, and I say, what are the best arguments against doing X? And they say, there aren’t any good ones, it’s obvious that you should do X, then that is advice I should entirely dismiss.

And I’ve also learned over time that I am unlikely to be well helped by those who, when I say, well, what should I do now? Say, well, if I were you, what you need to do is think about X. There are a lot of things I’ve got to think about. Well, I’d consider Y. Well, you really need to take account of Z. Yeah, I got all that. But could you please tell me – here’s my telephone, here’s my computer, here’s my network of people, here’s the position I hold. What would you advise me to do? The ability to answer that question in a concrete and direct way turns out to be enormously important. And so cultivating the skill of having a view, a clear answer to the question, what is to be done, but at the same time a recognition that you can’t be certain that your answer is right, that conditions may change and they may cause your answer to be wrong, and an awareness of the uncertainties, is a very crucial part of succeeding.

I think if you look at people who are able to know what they want to do, but able to see it in an objective fashion, who are able to develop and work with a network of people who they’re able to teach to share their vision, who are able to persevere in the face of temptation, and who are able to set and maintain a priority and a focus, rather than being tempted by all the important and exciting people, those are the people who ultimately have the largest and greatest influence on the world. And so those would be my bits of advice to you.

Just to be provocative, I will in conclusion share these views. The U.S. recovery is likely to persist, not at an especially rapid rate, but it is clearly likely to persist. The European financial situation is seen as bad, and is in fact worse that it is seen as being. The Japanese earthquake will be a substantial event, but will be a less substantial event when viewed historically 10 years from now than it is viewed today. The defining story, when the history of our time is written 150 years from now, will be the rise of Asia, and how that rise plays out with the prospects for very great opportunity or for very, very great risk. That the developments that will be enormously important also will be the changes in technology. That when it has not yet been the case, but that when somebody looks back 75 years from now, changes in life science technology, in medical, in health, in medical things, in the capacity to augment human capacities, will have been as significant or more significant than changes in information technology for the way in which society functions. And that the struggle is going to be to maintain the broad legitimacy of institutions in a world where there are so many forces pulling in so many directions. Let me stop there. I’m happy to respond to anybody on anything.

M: Dr. Summers, thank you for addressing us, and for your time.

My question is about mentorship. You mentioned –

SUMMERS: You were going to introduce yourself.

M: Oh, I’m the other Sanjay Gupta. (laughter) You talked about mentorship, and this is something important even my life, and I was wondering if you could expand more on your thoughts about it, thoughts on what the proper role of a mentor is, who are some of the key mentors you’ve had in your life and how they shaped your career?

SUMMERS: The two people who had the greatest influence on my career were Marty Feldstein, a professor here who was my thesis advisor and teacher in graduate school, and showed me the how, and sort of inspired me in the broad concept that one could apply the scientific method of mathematical and analytical techniques to economic questions and policy questions in a way that was relevant for policy debate, and who showed me how one could do that by carrying on research in a way that was rigorous, but at the same time was very relevant to policy concerns.

And Bob Rubin, who I was privileged to get to know relatively early in life, but to work with closely at the Treasury Department for a number of years, from whom I learned a great deal about leadership and management. Leadership and management came sort of naturally to Bob. It didn’t come equally naturally to me. More analytic things came more naturally to me. But I wanted to learn, and so by watching what he did, trying to understand consciously things he did unconsciously, I found I was able to learn a great deal about leadership. Both liked what they did, or cared about what they did, and were generous of spirit towards others. And so being probably the most important two attributes in a mentor are a willingness to be a little bit self-conscious about what you do and what you do well, and to think about why you do the things you did, how you do the things you did, and what the reasons are for the choices that you make. And I have found in life often the need to explain something to somebody else causes me to understand better why I’m making the decisions that I’m making. So a willingness to reflect on how you’re functioning, and being of generous spirit, and not feeling competitive with those that you work with are all important.

Bob always had the view, when he was Secretary of the Treasury, that anything he didn’t need to do, he needed not to do. And so if there was a speech that needed to be given, if there was a reporter that needed to be talked to, something that somebody else could do and it would be equally effective for the department, that was better, not worse. I think many of us have a more natural tendency to suppose that we really like doing what we do, and we’re good at what we do, so we’ll do as much as we possibly can. And that’s often good in the short run, but it’s usually less healthy for an organization.

M: I’ve been with the World Bank for the past 12 years. We met in Davos. I’m Originally from China. You mentioned in the last part of your opening speech, about the rise of Asia as one of the central themes, but I actually have a question about the U.S. I think the perception out there in the international stage about the U.S. is that, in addition to a lot of very specific problems, in terms of economic problems, political problems, I think the central problem is a lack of direction. I was talking to Chairman Lou Jiwei from CIC a few months ago. He said his largest
frustration is whenever he meets with policymakers in Washington, they gave him a different story about how this country’s going to go forward. And it’s very
different from China, right?

So look at the Chinese case, a lot of problems, but there is a general consensus about where the economy is moving, in terms of domestic consumption needs to go up, in terms of coastal area economy moving inland, in terms of urbanization. There is consensus about where the country is going. The difference is how do you get – the U.S. is like, there’s no agreement. That’s really an issue, is it not? Is there – I just don’t know what’s your view. Do you think that that sort of a status quo lack of direction is going to persist because of the nature of the political system, or do you think at some point, people will rally behind some general direction? Thank you.

SUMMERS: I think it’s a thoughtful and a very deep question. I’m not sure I fully accept its premise. Its premise is that having a direction is good, and I guess if you made a list of positive adjectives and negative adjectives, aimless isn’t usually an example of a positive adjective. And that sort of makes your point.

On the other hand, having a direction, having a clearly set direction and being relatively true to your direction, is really terrific if it’s the right direction. It’s really not actually terrific if it’s the wrong direction. There are probably people here who know more about the history of entrepreneurial successes, but what is striking about the history of entrepreneurial successes is how often the companies morphed in very large ways from what was their initial concept of their mission, and I think it is one of the great strengths of the United States that it has a kind of resilience. And that resilience is related to just what Lou Jiwei was condemning – the fact that it was less of a top-down society, the fact that there’s less coherence and cohesiveness on a single direction.

John Kennedy died believing that Russia would surpass the United States economically by 1985.3 And the reason he thought that was Russia had a higher investment rate, Russia had more engineers, Russia had fewer lawyers. Russia had more of a clear national purpose and a national strategy that was tied around technology. Russia was less focused on consumer frippery, automobile model changes and the like, and was a more disciplined society with a more disciplined educational system. For those reasons, it historically had faster growth. It had a clearer sense of national direction, and it would surpass the United States.4 That was widely believed in the United States in the early 1960s.

It was – if the young global leaders had come to the Kennedy School in 1990 and they had spent 10 days here, I promise you that at least eight people would have told them that the Cold War was over and Japan and Germany had won, and the United States had lost, because those were economies committed to investment, determined to succeed, with national strategies focused on developing the industries of the future.5 And yet, the more entrepreneurial United States, where guys with sweatshirts were starting companies and stuff like that, turned out to be more effective, and the United States boomed in the ’90s and actually pulled away from those countries.6

And I think something like that is probably relevant today. That doesn’t mean that the concerns are unwarranted. It doesn’t mean that there aren’t important respects in which the United States needs to pull up its socks. But I think the desire for national direction is a somewhat problematic concept in the modern world, because it raises questions about resilience, adaptiveness, and ability to do that. In the information technology space, the French had a terrific national direction in termsof Minitel.7 Didn’t actually work out that great relative to the Internet. There was a huge movement that felt that, 20 years ago, the United States needed to be in high- definition TV, that that was really the source of direction. Didn’t really work out that great for those who pursued those investments.8

So I would be very mindful of our flaws, but I wonder whether, when somebody looks back 25 years from now, is the problem going to be that the United States did not have enough direction in 2010, or is the problem going to be that China was insufficiently adaptive to the challenges created by its own growth and by a changing world.

DRUMMOND: Jamie Drummond of the advocacy group ONE. And from the point of view of being the seniormost policymaker in your field globally, what are the characteristics – what were characteristics of most good advocacy versus bad advocacy, and are there things that you wish there were people focusing on and advocating for that you do not see, and you wish there were people stepping up and focusing on, that you think groups like us should be focusing on that we may not be?

SUMMERS: I’ll give you my answer, but I may be an unusual customer for advocacy, so I wouldn’t necessarily, if I were you, give too much weight to my opinion– so the answer I’m going to give you is entirely faithful to what I think, but I’m not 100% certain I’d follow the advice if I were you.

It’s an observation in financial markets that anything that everybody knows is already reflected in the price.9 And the only thing that moves the financial market is something that’s unexpected. Well, and the same thing is, roughly speaking, true of the recipients of advocacy. So I’m the Secretary of the Treasury, I’m the President’s economic advisor, I’m sitting in my office, and somebody comes to see me. I’ve done this for a while, and most people who are doing it have done this for a while. So the steel industry comes and explains that the steel industry is important, and favors more support for the steel industry. This is really unlikely to change anybody’s mind. It was kind of expected. Anti-poverty group comes, says there’s a lot of poverty in the world, urges more efforts to combat global poverty, says that global poverty is a big problem, and even in difficult budget environments, is so big a problem that funds ought to be found for it, but doesn’t know how to find the funds. This is not news.

And so I would say the number one attribute of effective advocacy is something that is communicated to the person being advocated to that the person being advocated to would not have expected, would not have already known, and would not have expected to learn in the 20-minute meeting. And most of the time – I was always surprised by the fraction of the people who would come to my office and wouldn’t know this rule. And I would often try – mostly it served to irritate them – but I would often try to get there. I would say, let me stipulate that. And I would do, for whatever their sphere was, the equivalent of the thing they said. I would do it in three minutes. And then I would say, so let’s stipulate all those things, and I believe very much all those things. What else can you tell me? Or what do you think we should do? Or why do you think, given the force of your argument, this isn’t already happening? And I found most people would only go back to their thing. So with respect to advocacy, if you ever want to advocate something, tell the person you’re advocating to something they didn’t know before- this is the way to be effective.

I would say that the other part of being an effective advocate is it’s about them, not about you. Good advocates come and tell the President of Harvard why it would be good for Harvard to do X, not why X is good, and therefore Harvard should be part of it. And so advocacy that is attached to the person that is being advocated for is, I think, very important. If I look at the world, I think the things that are under- advocated are the things that don’t have natural constituencies. So producers have natural constituencies, consumers don’t have natural constituencies, so there’s too little advocacy for free trade, because the beneficiaries of protection know who they are, the beneficiaries of non-protection don’t know who they are. The beneficiaries of subsidies for a particular production know who they are.

The beneficiaries of more rapid progress in basic science don’t know who they are. So I would say the category of the unadvocated are those with desirable ideas but with a diffused constituency. Precisely because it’s difficult to mobilize funds for people who don’t know who they are, it’s difficult to mobilize excitement for people who don’t know who they are. So I would think of the task of finding subjects to advocate heavily around things that don’t have a natural constituency.

F: I see four more people, is that correct? These are going to have to be our four last questions. Thank you.

LISA: I’m curious about your thoughts about radical thinking. A lot of the approach to solving problems hinges on incremental change. Yet, do you think that the world is doing – and when I say radical, I don’t mean like violently radical, I just mean taking problems and flipping them upside down- is there enough radical thinking going on in government? Is there enough radical thinking going on in business and in nonprofits? Are we sort of sticking into the buckets that we know, and if we are, what are we missing?

SUMMERS: I’m not sure I know how to answer that question, but it’s a very good question, and I’m not sure I know, Lisa, how to answer it in the abstract. I think my basic view would be that the world probably does too few experiments, and probably – but probably doesn’t do too few lurches. So what I mean by that is this- take an idea that – I don’t know how it’s actually playing out, but there’s a professor here who is interested in the idea of basically, you’re a nine-year-old, you read a book, we’ll give you $2. So basically paying people to read. You know, the idea was, paying kids $100 a year to get them to read 50 books- it seems awfully economic in a world where school budgets are $17,000, and if you can make it work, it’s really a tremendous thing. There are a million other people who thought it was offensive, undermining values of loving to learn, and so forth.

My reaction to an idea like that was, you shouldn’t decide whether it’s a good idea or a bad idea. You should do an experiment somewhere, and see whether it works or not. I personally am no fan of school vouchers. I was appalled by the Clinton administration policy of violently opposing the experiment with school vouchers in Washington DC, not because I thought school vouchers were a good idea, but I thought one should see whether radical ideas were good ones. And that since there’s disposal of bad ideas, more ideas are good, and if you do a bunch of experiments that have a one in 60 chance of working, occasionally they’ll work, and the ones that work can be spread. So I think finding ways to do more experiments with apparently flaky ideas is something we as a society should work to encourage.

Conversely, I think that things have unintended consequences, and so radical policies that people propose to implement nationwide are almost certainly bad ideas. So whenever somebody comes and says, we did one pilot in one place with 62 people, and we should extrapolate the study to have a new national jobs program, my reaction is, well, let’s try it in more cities and see what happens. So more experimentation with radical ideas, but slowness in the world moving to adopt radical ideas on a large scale, would be the kind of vision that I would favor. So it’s a more mixed story.

JAY: Hi, my name’s Jay. I’m interested in your reflections on the financial crisis, and many people believe that the banks were good at privatizing their profits and socializing their losses. And obviously, you have to stop the economy from going over the edge, but looking back, is there any way that you think the U.S. administration could have privatized a bit more of the losses somehow?

SUMMERS: Battlefield medicine’s never perfect, and there’s unintended victims in war, and there are unintended beneficiaries in bailouts. I think, in the fullness of it all, the response to the crisis was pretty well managed, which doesn’t mean there aren’t some respects in which it could be improved.

One of the systematic errors that I believe people make, and that is very frequently made in looking at governments and in looking at other large organizations, is to confuse malevolence and incompetence. I know something about the management histories of a number of the major financial institutions. If you want to accuse some of the CEOs, some of those fairly senior positions, of fairly extreme stupidity, I would not attempt to make a defense. If you want to express surprise that they could have been as oblivious to risks that their organizations were running, I wouldn’t fight you. If you expressed puzzlement that they were as telescopic in their vision, without using a wide-angle lens in a complicated world, that would not be a proposition that I would fight.

But if you think that the guys who ran Lehman Brothers, who had 90% of their stock in Lehman Brothers, somehow were taking risk because they figured that the government would bail them out, and that it would sort of be OK if they failed, I don’t believe that for a minute.10 I don’t believe it for a minute. And yeah, you can say that, were they allowed to take more risk – a better argument would be that they were allowed to take more risk than they otherwise would have because the people who lent them money lent them money to a higher leverage rate, because they thought they would be bailed out. Maybe to some limited extent.

But do I believe that the guys who built the nuclear power plant in Japan were thinking, well, there is going to be government bailouts and the government’ll take care of it if the earthquake hits? That’s a way to understand that problem, that they were just – had their incentives to be cautious dulled by the fact that the government would help take care of it after the earthquake? Or is the right way to think about it that they sort of felt impervious, and there hadn’t been an earthquake for a long time, and there probably wouldn’t be an earthquake? I think it’s much more the second.

So I personally think that it is very easy to overdo the risks, overdo the moral hazard aspects in thinking about this relative to underrating the incompetence. If you own Citigroup stock today, you could make some set of arguments that it would have been better if Citigroup shareholders had lost 100% of their money, but they did lose 96% of their money, and maybe it was an important difference between 96 and 100, but I suspect that nobody’s thinking, well, it’ll be kind of OK to kind of have another financial disaster, because the government’ll come in and bail it out.11

So I don’t think that the failure to privatize losses sufficiently is an important part of the cause of excessive risk-taking. I think there’s been enough pain and suffering that nobody’s going to knowingly take big risks for the next 25 years, and I think whatever we do now, nobody’s going to remember it 40 years from now, so we don’t have a big opportunity to address that.

Would it have been better ex post to have inflicted some more pain around the financial sector? You can make that argument. It certainly would have been fairer. It certainly would have been more just. But I guess my reaction to that is, it’s a little bit like when my wife and I bought our house. We bought our house – my wife loved the house, just loved the house “we’ve got to buy this house, Larry, there’s no question, we’ve got to buy this house.” There’s a bidding process, we’re negotiating with the seller. We bid X, the seller says yes, we get the house, and we turned to each other and said, damn it, we probably could have gotten it 5% cheaper if we had just held on longer.

It is very easy to say right now that we could have inflicted more pain and still had a successful restoration of confidence and all of that, but you really wouldn’t have wanted to take the chance of being wrong. I would rather put more emphasis on raising capital and reducing leverage to reduce the brittleness of the financial system than to put the primary emphasis on a change in the terms of bailouts.

I think that the problem with the simple intuition versus the actual reality of financial crisis is, the story is always about an individual institution that takes risks, and gets itself in trouble, and the incentives for risk-taking by an individual institution. But in fact, if you look at all the failures, none of the failures take that form. None of the failures are ever because an institution is sitting in the midst of a tranquil sea taking too much risks. It’s either because they screw up with internal controls like Drexel Burnham, and do illegal things or something like that, or it’s because the whole system has a crisis at once.12 And neither of those problems is hugely well addressed with a lot of this privatizing the losses stuff. That’s why I’m for it, but I wouldn’t put my primary emphasis on it.

M: I’m from South Africa. On the way over here I watched the movie The Social Network. I assume you’ve seen it. My question is, was its portrayal of you accurate? (laughter)

SUMMERS: I had a feeling that one might come up. (laughter) How many people have seen the movie? I’m told that the Winklevii were quoted as saying that the movie was fairly accurate, except Larry Summers was not as nice to us in person.(laughter) On the one hand, I certainly did not tell anybody to punch me in the face, and the exact dialogue is wrong. On the other hand, the Winklevii did come swaggering in with singular arrogance, and I’ve read a few times that I can be arrogant, and (laughter) if that’s true, I surely was on that occasion. (applause) (laughter) I think there was nothing it portrayed, however, that was not something that actually happened at Harvard, but I think it was rather selective in its portrayal of Harvard. And I might also say, as somebody who knows Mark Zuckerberg pretty well, he is a significantly sunnier and more pleasant figure than is suggested by that movie.

M: I have two questions. The first question is, as much as everybody’s talking around the world about the rise of Asia, and China and India, I do believe the rise of Asia could be predicated on the success of the United States. What I do worry about, in the United States, is the fact that, given the shift in manufacturing to China and India, given the shift in innovation that’s happening, and given the unemployment rates in the United States- can the United States rise again?

The second question I have is that from the success the last few years in India, there’s also a dark side to it that’s coming out right now in terms of scams and corruption, etc. I’d like to get your perspective on what you feel a country that’s in that kind of environment right now- on the one hand we’re doing very well, on the other hand, there is a bit of a dark side- what should we be doing about it?

SUMMERS: These are very good questions, and you guys are giving me a lot to think about. I’m trying to think about – here’s my guess. My guess is that if you study all countries, and you study their rise, you will discover that they sort of go through three stages. They were invisibly corrupt, but you didn’t see the corruption, it didn’t get reported in the papers, people weren’t real angry about the corruption, and it was just part of life. Then there’s a second stage, which is everybody’s really angry and upset about corruption, which is when the corruption becomes visible
and observed, and that’s when anger at corruption is at a maximum. But actually, by the time you reach that point, the peak of corruption has actually already passed by some significant margin. And then there’s a third stage, which is, there’s a relatively vigilant press, and a general relaxation of controls, and corruption goes down.

One of the things that people never talk about when they talk about corruption is, if you have a price control, then there’s a black market, and there’s a white market, and there are two different prices.13 And stuff can be moved between them, and therefore, there’s corruption. If you have capital controls, then there’s underinvoicing to move money out of the country – or overinvoicing – to move money out of the country, and then there’s corruption.14 If you don’t have price controls, and you don’t have capital controls, then you can’t have the corruption.

So I think, if you look at the development of most societies, you’ll find that there are three stages, and you’ll find that there’s the highest degree of agitation over the issue when you’re in the second stage, even though the worst of the issue was when you were in the first stage. So if I looked at how the Congress Party won elections in Nehru’s time, or in Indira Gandhi’s time, how licenses were awarded in the License Raj, what the capacity of civil servants to get privileged access to education for their kids, who had particular aspect – particular abilities to get their kids into the right schools, who was able to take money out in order to travel in India- it would take a lot of work to convince me that, in any meaningful sense, there was more corruption in India today than there was 25 years ago.

What is the answer? The answer, I think, is outrage, transparency, and removal of opportunity. And I think things are, in general, moving in that kind of direction. An important aspect of this that I don’t really fully understand, and don’t really know how much it’s moving, but where I’ve heard – less relevant to India, but is more relevant to corruption in some other context – is I think that it is considerably more difficult to be a deposed leader with a billion dollars abroad, and keep the billion dollars abroad, in 2011 than it was in 2002.15 And if that’s right, that’s not a small thing, in terms of how the world will evolve. It’s not, by the way, a completely uncomplicated thing, because if you actually want to depose bad-guy leaders, you probably do need to give them landings that are acceptable if you don’t want them to hold on absolutely until the last gasp. But that is an area where there has really been some quite important change. Again, I don’t think that’s as relevant in India as it is in some other countries.

Your other question was about the United States. Sort of for the reasons that I said in answer to somebody else’s – to your question, I think I’m more optimistic about the American future than many other people who follow it. I am less certain that wealth in the 21st century is going to reside in manufacturing prowess than many other people are. If you look in the United States right now, about 5% of the jobs are production work and manufacturing.16 The statistic that’s widely quoted is double that, but that includes all the secretaries, that includes all the people who handle advertising and finance. If you look at the number of people who are actually on factory floors producing things, you’re in the range of the fraction of people who were farmers a generation ago.17

And so – and I suspect that what’s going to happen over the next 20 years is you’re going to see some return of manufacturing to the United States, and the reason you’re going to see some return of manufacturing to the United States is that, if it’s all done by robots anyway, it doesn’t really matter whether wage rates are lower in China or India than they are in the United States. So the strategy that is based on industrialization for job creation, I don’t believe, is real. Industrialization may happen, but I’m not sure how much wealth creation is going to happen out of the industrialization that can happen.

I think that the wealth creation is going to come more from acts of creation and innovation. And I think the question is going to be how do you cause the wealth creation that comes from acts of creation to be sufficiently widely distributed, since acts of creation are likely to be – have a high fraction of them done by a relatively limited share of individuals.

F: Thank you so much, Larry. (applause)

1 David E. Sanger, “Mexico Repays Bailout by U.S. Ahead of Time,” New York Times, January 16, 1997.

2 Matt Richtel, “Even at Megastores, Hagglers Find That No Price Is Set in Stone,” New York Times, March 23, 2008.

3 Steve Forbes, “Copernican Revolution Coming to Economics,” Forbes Magazine, January 17, 2011.

4 Martin Walker, The Cold War: A History, Henry Holt & Company, Inc., 1993.

5 Harvard Business Review, January-December 1991, available at http://hbr.org/archive- toc/3911.

6 Michael Lewis, “In Defense of the Boom,” New York Times, October 27, 2002.

7 Barry James, “Beyond Minitel: France on the Internet,” New York Times, January 8, 1996.

8 Kathryn Jones, “The Media Business: Zenith Wins Competition for HDTV,” New York Times, February 17, 1994.

9 Jeremy J. Siegel, “Efficient Market Theory and the Crisis,” Wall Street Journal, October 27, 2009.

10 Heidi N. Moore, “Congress Grills Lehman Brothers’s Dick Fuld: Highlights of the Hearing,” Wall Street Journal, October 6, 2008, available at http://blogs.wsj.com/deals/2008/10/06/dick- fulds-grilling-highlights-of-the-house-committee-hearing/.

11 Julie Satow, “Citigroup Stock Sinks to An All-Time Low of 97 Cents,” Huffington Post, March 5, 2009, available at http://www.huffingtonpost.com/2009/03/05/citigroup-stock-sinks- to_n_172167.html.

12 “Predator’s Fall: Drexel Burnham Lambert,” Time, February 26, 1990.

13 Simon Romero, “Chavez Threatens to Jail Price Control Violators,” New York Times, February 17, 2007.

14 Stephen Fidler and Jon Hilsenrath, “Countries’ Rising Use of Capital Controls Stirs Debate,” Wall Street Journal, January 29, 2011.

15 Deborah Ball, “Mubarak’s Swiss Assets Frozen,” Wall Street Journal, February 11, 2011.

16 Bureau of Labor Statistics, “Occupational Employment and Wages,” May 14, 2010.

17 United States Department of Agriculture, “The 20th Century Transformation of U.S. Agriculture and Farm Policy,” June 2005, available at http://www.ers.usda.gov/publications/eib3/eib3.htm.