Challenges Facing the United States

/in

March 23, 2011
Harvard Club

Thank you very much for that generous introduction.  Thank you, students, for upstaging me completely.  (laughter)  Joe, I may have been born in New Haven, but I was rooting for the Red Sox before your father met your mother.  (laughter) I’m going to talk in a minute about sort of major challenges facing the United States, the work that we did with President Obama on those challenges.  But I believe that none is more important than the challenge of equal opportunity.  We are an unequal society in ways that probably can’t be changed.  We have become a less equal society.1   Much of that goes with the market system.

If we are going to be an unequal society it is not acceptable for everyone to not have a fair chance to succeed, regardless of where they were born and into what circumstances.  Nothing I say to you is more important than it: that the United States stay what Thomas Jefferson called it, an “aristocracy of talent.”2   Your University has been at the forefront of efforts at inclusion for many years.  The first idea of financial aid on a significant scale came from Harvard under President Conant in the 1930s.3   President Bok and President Rudenstine led the efforts to assure equal opportunity for students from every racial and ethnic background on a national basis.4   And I am proud that during my time as President it was possible to ensure that any family with an income under $60,000 would have to pay nothing to send their child to Harvard.5

And I applaud and I admire President Faust’s efforts to extend the principal of equal opportunity to ensure that no middle class or upper middle class family will under any circumstances have to pay more than 10% of their income to send their child to Harvard.6   Harvard has, Harvard will, and Harvard must continue to do its part to ensure equal opportunity in the United States.  And we have seen here tonight two powerful examples of that commitment to equal opportunity.  Let’s congratulate them.  And let’s especially congratulate their parents.  I said in the last commencement address that I gave that great universities and great nations at their zenith had the settled risk of complacency.  That they must never become complacent.  Little did I realize, as I said those words, how much complacency in markets was going to prove to be a problem for our country.

Through the early and mid part of this decade a sense of enormous optimism ensued.  That optimism, to be sure, had a rational basis.  An economy with a flexibility and resilience in capacity for innovation that was second to none.  An American workforce with a potential to produce that is unmatched around the world.  A capacity for intellectual innovation and its application in the United States that is unlike any other.  But that confidence went to excessive heights.  You saw it in credit spreads that bore no resemblance to actual risks.7   You saw it in the inflation of asset values in housing and real estate beyond any reasonable relation to the fundamentals.8   You saw it in the hubris of financial institutions that took on degrees of leverage that left them unprepared for any negative event.9

And so beginning in the summer of 2007, moving through the events of Bear Stearns, to the catastrophic month in the fall of – September of 2008, when Lehman Brothers and then AIG collapsed.10   When it was an open question at one point whether the General Electric Corporation would be able to borrow money for a full week in order to meet its cash flow obligations.11   Our economy came as close to collapse as it has since the Second World War.  In November, Barack Obama was elected as our President.  Elected as our President in part on the basis of a commitment he had laid out over two years to renew the American economy and to renew the American society.12   And frankly elected in part because at a moment of enormous anxiety, fear and distrust in institutions, there was a sense that America had to move to something new.

I was honored and terrified, but felt ready to respond to President Obama’s request that I use what I had learned in a short lifetime of research in economics, and during the years in the Clinton administration when I had worked with Bob Rubin, with Bill Clinton and with many others on a set of financial crises that fortunately were not American financial crises. People ask me when I took on this task how I would know whether President Obama had succeeded.  I gave them this answer.  I said that my twin daughters, who some of you have met, had just finished their study of advanced placement American history in high school.  And that I had been struck by what they had learned and by what they had not.  That events that seemed very important to me, the 1987 stock market crash, the terrible recession of 1982, were not important enough to figure in their course in American history.

On the other hand, the events of the 1930s and all that followed from those events in the 1930s were the subject of five weeks of study in their course.  Five weeks of study because of all that was wrong that happened.  Because of the wars that followed from the Depression.  And because of what was constructed during that period, unemployment insurance, Social Security, The Securities and Exchange Commission, and much, much more.13 And I said that we would succeed, we could think ourselves successful if when the history of this time was studied 40 or 50 years from now – of course economists in their economics courses would study this financial crisis – but in general, students of history did not have to see this as a defining historical event.  But if there were something that had been left behind that made our society a more fair and a more just one, then we would have succeeded. If we had the fortunate legacies of the 1930s, but we did not have the unfortunate tragedies of the 1930s.

I believe that by that standard President Obama has been successful in his leadership.  Make no mistake, the risks were immense.  Between September of 2008 and March of 2009, stock prices fell faster than they did after Black Tuesday in 1929.14   World trade fell faster than it did in any six-month period during the Great Depression.15   And the economy lost jobs more rapidly than it has at any point since the statistics began to be calculated.16   Just as we can look back at the Cuban Missile Crisis, and not know just how great the risks were, but know that we were far closer to the edge of Armageddon than could possibly have been comfortable, we can look back at that moment and see something similar now.

We made a judgment.  A core judgment that shaped our strategy going forward. And it was this: in the face of vicious cycles going in every direction – asset prices falling, people being forced to sell because they were on margin, that selling forcing them down further, financial institutions in trouble, indiscriminate lending meaning more assets, meaning asset prices fell, meaning financial institutions in worse trouble, a banking system that was collapsing leading to an economy that was collapsing, leading to more trouble from the banking system – in the face of those vicious cycles there was much more risk from doing too little than there was from doing too much.  And that’s why in the first six months of 2009 we committed, as a nation, close to $900 billion to support and save local governments, investing in infrastructure, providing funds to consumers to enable them to keep spending, and providing expanded unemployment insurance for those who were unemployed.17

That’s why we forced the first wholesale examination of the quality of all of the assets in our major financial institutions, and insisted that there were shortages of capital, that capital be raised, not provided by the government, but raised from the private markets.18   That’s why we made the decision, not an easy decision, that extraordinary times call for extraordinary measures.  And the government insisted that two of the three major automobile companies go through bankruptcy, but was prepared to provide the debtor in possession financing to ensure that they were able to continue to operate.19   And that is why the government committed to lead, on an unprecedented scale, a global effort to resist protection and provide finance to emerging markets that depended on the rest of the world.20

Any one of those things would have been a single and unprecedented act in normal times.  All of them happened within the first six months of 2009.  Have the results been satisfactory?  Hardly.  Battlefield medicine is never perfect.  The unemployment rate is far too high.21   Recovery is not as rapid as we would like it to be.  But today we can say that the American economy has been expanding for 18 months.22   We can say that the unemployment rate has declined by a percentage point in the last three months.23   We can say that asset prices are no longer in free-fall. The stock market, despite all the talk about how there’s been some kind of socialist attack on business, the stock market is nearly twice as high as it was on the day the President was elected.24   There has been no two years that would have been better to own stocks in the last 100 years, than the two years that began two years ago.25

That is a success.  It is a success that above all is a reflection of the President’s determined leadership oriented at doing the right thing.  It is also a success of a set of ideas, a set of ideas about how the macro economy works.  A set of ideas about how not all these economies are self-equilibrating systems.26   A set of ideas about how financial institutions work, that is the product of what goes on in universities like ours.  No university in the world contributed as much, or in this country, contributed as much to bringing the ideas that were really first John Maynard Keynes’ ideas about how sometimes economies are not self-equilibrating systems,27  to the United States, as your university did.  So this was a triumph proximately of political leadership, but more remotely, but no less importantly, of the kind of hard thought and serious reflection that goes on in great universities.

Make no mistake, there is a great deal that was – that is abstract and remote in the research that goes on in places like this.  But as someone who was asked to provide a briefing on economics to the President of the United States every morning, I can tell you that I found myself reporting on the research and work that was done by a remarkable number of my colleagues here at Harvard that contributed to the thinking that I believe helped us avert what could have been a very real catastrophe. One of the things that I admire most about President Obama is that he is absolutely committed to an approach to leadership that I in a small way tried to – have tried to pursue at various positions that I have held.  He believed that it was much better to try to do too much than to simply sit still.  That it was better to have one’s failures be failures of boldness, failures of striving, than to be failures of complacency or acceptance of the status quo.

It would have perhaps been enough to focus only on preventing this financial Armageddon that was a real possibility.  President Obama also made a judgment  that if the United States was going to do anything about a healthcare system that – as we found it in 2009 managed to spend twice as much as a share of income as any other country in the world,28  in order to provide life expectancy that was not in the top 15 in the world,29  while leaving 50 million people without coverage,30  that allowed only roughly 25% of hypertension in the United States to be effectively controlled31 – he made a judgment that that was unacceptable.  And he made a judgment that if it was going to change, it was going to be changed in the short window of opportunity that a President has at the beginning of his term.

And that’s why it was an honor to work with him to legislate change in our healthcare system.  There’s plenty of debate about, about that bill.  I am sure there are things in that bill that are not as they should be. I am sure that it will need to be amended in important respects in the future.  But I am much more certain that if that bill is repealed and abandoned and we allow the trends that let there be 30 million, and then 40 million, and then 50 million people uninsured,32  that let there be 10%, and then 12%, and then 14%, and then 16% of GDP be devoted to healthcare,33  that let us be fifth, and then tenth and then 15th  and soon 20th in life expectancy,34   that allowing those trends to continue without doing anything would have been a far greater error.

I spoke about the challenge to provide an equal opportunity.  Harvard, I believe, has done much of its part.  It won’t have done all of its part as long as Harvard continues to be a place where, let’s say it, it is easier to get financial aid to come and study to be an investment banker, than it is to get financial aid to come and be a teacher.  So we’ve got work to do at Harvard.  But around this country, despite the things that we have done, despite some of the great initiatives at other universities, the chance of going to college if you are – if your parents are in the upper part of the income distribution, is still far greater than if your parents are in the lower part  of the income distribution.35   And that gap has widened over the last 30 years.36 And that is a challenge.  It is a challenge of providing adequate resources.  Even more fundamentally, it’s a challenge of strengthening and improving our public schools.  That’s a challenge.

We are reminded by what we see on the news every day that, yes, we have this remarkable capacity to innovate and develop.  But Presidents of the United States have been talking about reducing our vulnerability to Middle Eastern oil literally for as long as I’ve been rooting for the Red Sex.  It started in the early 1970s.37  And at long last the Red Sox did win two World Series.  (laughter)  But we are still dependent on Middle East oil.38  And the Middle East has not gotten more stable.39 It has not gotten safer.  It has not gotten more reliable in the last 35 years.  But we have huge challenges.  We passed legislation, I’m proud to have helped work with the leadership of Senator Dodd and our very own Congressman Frank that I believe reforms financial regulation in important ways.  But if you think we’ve seen the last financial crisis of the United States, I have a bridge that I’d like to sell you. (laughter)

We have a lot of work to do. Each of these problems is a problem and a challenge in part for political leadership, in part of persuasion and commerce.  But each of these problems is also a problem that needs new thought, that needs new understandings.  And that’s why while men who go off and work in Washington come away thinking that the abstractions, the books, the articles, the studies that go on in universities are so abstract and irrelevant.  I come back with a very different feeling.  I come back with the feeling that “God, the world needs more thinking if it’s going to solve these problems.”  And I cannot imagine where that thinking, where that objective, honest, truth seeking is going to come from, if it is not going to come from our great universities.  And I know that there’s no greater university than our university.  And that’s why I am so glad to be back at Harvard.  Thank you very much.

M:    Larry’s open to a question or two if we have any from the audience.  We have microphones on either side.

SUMMERS: Yes, sir.

M:    As a non-economist, someone with a military background and an oil business background, could you explain to me how the current administration, and past administration defines inflation not including the price of food and the price of oil?

SUMMERS: There’s a concept that Congress talks about all the time which is core inflation, which is inflation not including food and oil.40 Of course, it’s kind of bogus to talk about inflation leaving out the stuff that goes up in price, when that stuff is food and oil.  (laughter)  It’s absolutely bogus, of course.  Here’s the point, though.  If you want to measure the price of food, the price of oil, the price of commodities, they bounce all over the place.  There are a lot of other prices that are much more safe.  If you want to measure the underlying inflation trend you turn out to get better measure of the underlying inflation trend from looking at the price excluding oil and food than the price including oil and food.41

That doesn’t mean when they want to measure incomes you have to measure the relative prices and those prices include food and oil.  It’s just that when you have a relatively high inflation rate for a quarter, because of food and energy, it tends to go back down the next quarter.42   And when you have relatively high inflation rate because of labor costs, it tends to keep going.43   And that’s why economists draw the difference.

M:    Of the Clinton Cabinet and Clinton Joint Chiefs, Obama Cabinet and Obama Joint Chiefs, my question is twofold.  A, who would you rather have with you of all of them in a bar fight.  (laughter)  And B, who would you rather have a beer with? (laughter)

SUMMERS: You know, those of you who – some of you know me, and some others of you have probably watched me over time.  And I think that I’ve probably demonstrated an ability to get myself into a substantial amount of trouble (laughter) with non-tactful statements without being invited to do so in response to questions. (laughter)  So I think I’ll stay off that with the rather venal observation but that has the virtue of being true, that I think it’s been a remarkable group of people that I’ve had the chance to serve with in both of the administrations that I have worked with. I will only comment on one person who I both enjoy having a beer with and admire enormously.  My very good friend, and a man who was in many ways a mentor to me, who has played a very important role at Harvard these last ten years as a member of the corporation, Robert Rubin, who served as Secretary of the Treasury for four years during the Clinton administration.44   I think he’s an enormously wise and thoughtful man from whom I learned a great deal.

M:    I hope I have a lighthearted question that you’ll enjoy answering.  When I was a grad student at Harvard, some undergraduates were working in their dormitory to create an Internet enterprise that turned out to be really successful. It even got turned into a film that was nominated for the Oscars.  So my question (laughter) is have you joined Facebook?  And what was your tipping point when you decided to join Facebook?  And do you have any thoughts on how the actor portrayed you in the film?

SUMMERS: I was waiting for this.  (laughter)  I knew this moment would come. (laughter)  Let’s see.  On the film, the Winklevoss were quoted as having said the only problem with the film is that Larry Summers wasn’t nearly as nice to us in person as he was in the film.  (laughter)  That may be right.  (laughter)  I’ve heard it said that I can, on occasion, be arrogant.  If that’s true, I surely was on that occasion. (laughter)  I did not find the particular complaints of the students to have enormous merit.  And I think I probably conveyed that rather clearly.  (laughter)

I will tell you that I’ve been on Facebook for a number of years actually because a woman who some of you may know, or know of, and who I suspect the Development Office may choose to get to know, Sheryl Sandberg is the number two person at Facebook.  She was an undergraduate student of mine, and went on to work for me at the World Bank.  And went on to work for me as the Chief of Staff during my time as Deputy Secretary and Secretary of the Treasury.  And when she went to Facebook she encouraged me to get on the Facebook site.  If she would have given me some stock instead it would have been better.  (laughter)  But she encouraged me to get on the Facebook site.  So I’ve been on Facebook now for a few years. But it is a remarkable kind of thing.  I can’t remember which year it was, probably 2006, I gave – I was to give the welcoming speech to the Freshmen.  So I had a speech that I gave each year, and we changed it around each year.  There was a student who worked in my office who was in charge of working on the draft and editing it a bit and so forth.  And the guy wrote this line in where he used friend as a verb. And I said, what’s this, and I used an expletive.  What’s this, friend is not a verb.  And he said, Larry, just say it.  I said what are you talking about?  He said, I promise you, if you use this term, if you say it – just read the words I have written, I promise you they will all laugh and they’ll think you’re cool. And we can’t take it for granted that they’ll think you’re cool, Larry.  (laughter) And I said, well, I’m going to read this line just as your wrote it, but your job here does depend on if I get them to laugh.  (laughter)  And I read the line and they all broke up.  But I had no idea what I was talking about.  (laughter)  Sad, but I did learn something about the power of the Facebook idea from that experience.

M:    Well, my name is Ben Voltra and I’m going to send you a friend request. Delightful speech, I truly enjoyed it and I must say that I agree with a lot of what you had to say.

SUMMERS: I have a feeling that you’re not going to be the focus of what follows. (laughter)

M:    Let me get to it.  In some ways, truly, I’m impressed with the overall approach of the Obama administration and what you have done and what you accomplished. Not just for America, but for the whole world.  One of the criticisms which I hear around the world, and I would like your comments on – it would be that there are too few people in the early years of the Administration who were businessmen. You just mentioned that dependence on oil.  The U.S. has a significant depository of gas. And almost all other developing nations and developed nations have moved on to natural gas.  So I’m saying gee, we could have perhaps spent an enormous amount of money, which we have spent, into developing synergy infrastructure, distribution systems, which would be visible, which would be very practical and would create new jobs.  And somehow that didn’t happen.  There was a lot to do, and I appreciate that.  And there was a huge crisis and I appreciate that.  But at the same time, do you think that you missed an opportunity in that sense?

SUMMERS: On the question of business people in the Administration, I think the President would say that if he had it to do over again he probably would have had somewhat more business representation in the Administration.  That said, let me remind anyone who thinks that the first two years of the Obama administration were anti-business, that there was no two year period in the last 50 when corporate profits rose more rapidly.45   That there was no two year in the period in the last 50, when the stock market performed better.46   That there was a major kind of problem that was being inherited.  And that it is hard to look at the level of profits today, not just in terms of the movement over the last two years, but relative to where they were in 2007 and somehow say the group that got squeezed in our society was corporations.

Could more have been done with respect to energy in general and natural gas in particular?  Probably.  The administration worked very hard to pass legislation. There was legislation, if passed, that would have included a variety of measures in terms of pricing carbon that would have done a lot to stimulate natural gas.  That measure actually passed through the House, but it was bottled up in the Senate.47

Perhaps there are things that the administration could have done to move it more vigorously, but there were a lot of other things that we were doing.  So directionally, do I have regrets in your direction? Yes, I do.  Do I think that given the circumstances we face, it would have been reasonable to expect far more to happen?  I guess I don’t think so.  But I could wish it were different.

M:    Thank you very much.  That was excellent.

M:    Yes, my question goes to your view of the stimulus bill in retrospect.  Prior to joining the administration, you made a set of remarks talking about the needs for stimulus to be temporary and targeted.  So in retrospect, can you estimate or guesstimate how successful you actually were in that goal?

SUMMERS: You know, I did in December of 2007, call before leaving, before AIG, before the economy was facing Armageddon, but when there was an incipient downturn, call for a bill that was timely, targeted, and temporary.48   In November of 2008, before I went into the Administration I said that I earlier called for a bill that was timely, targeted and temporary, but my new standard was speedy, sustained and substantial.  Because I felt given the seriousness of the problem, we needed something rather different than we had had before.  And the fact that today, two plus years later, we’re still looking at 9% unemployment,49  and nobody thinks we’re going to be without economic slack for a long time, I actually think that the stimulus bill that was passed was rather appropriate to the circumstances that we faced.

And if anything the danger is right now that stimulus may be withdrawn too quickly.  And if you ask me what the risks were to the recovery, I would say I was pretty optimistic about the recovery.  But the two biggest risks were a major oil price spike and excessively rapid withdrawal of stimulus.  So an excessively temporary character I don’t think as things had turned out is the major problem. Let me take one more question.  Yes.

M:    Some of the smarter investors that foresaw the subprime prices are now warning us about sovereign debt levels in The Wall Street Journal. They’re worried about sustainability of sovereign debt in developed markets, developed countries.  I think they’re fearful of some kind of exogenous event, some kind of hyper-inflationary situation.  My question is what do you think of that concern?  What are your views on that concern?  And to what extent does the Obama administration have concerns among these lines?

SUMMERS: Well, I don’t speak, at this point, for the Obama Administration.  Look, anyone who dismisses a risk out of hand is always making a mistake in economic policy.  And there are risks in every direction.  The challenge of policy is to balance and minimize risks, because you’re not going to eliminate risks.  If you look at the situation in Europe, I think it is very serious.  I think it’s a remarkable thing that’s actually remarked on too little.  That there are, I believe, as I speak, seven European countries that have risk spreads on their debt that are twice as great as the spread on Mexico or Brazilian debt.50   So the whole idea that these developing countries are kind of flaky and the solid industrial countries that are responsible really is a lie by the current experience.

I do not think that hyper-inflation is a substantial risk in the current environment. My reading of the available evidence and data is that there are almost no examples of a substantial inflation starting without significant pressure in labor markets, and significant increases in wage levels.  And as I look at most parts of the world today, I see increasing unemployment – not increasing, high unemployment and substantial slack and downwards pressure on wages.51  And so I see risks in the need for restructuring the debt in a number of parts of Europe.  I don’t think there’s any question that we, as a country, as our economy recovers, are going to have to take steps to bring revenues and expenditures into balance.

But I am more worried about a scenario that has something in common with the disasters Japan had in the 1990s. I have concern about a scenario that’s like the United States in the 1970s where inflation got out of control.52   But no prudent policy maker can fail to be worried about both possibilities.  It’s a matter of finding a balance.  I’ll take one more question, hoping it’s cheerful.  (laughter)

F:    Kind of.  So first of all, thank you. And so based on that, my question is what do you see as the challenges for states implementing insurance – insurance exchanges and how we’re going to move forward, assuming it’s Constitutional.

SUMMERS: I’ll say this.  Professor Tribe – some of you – if you’re interested in the Constitutional aspects, Professor Tribe, who I have enormous admiration for, had a very powerful Op-Ed in The New York Times about a month ago arguing that the bill was so constitutional that it was going to be upheld by the Supreme Court on a 9-0 vote.53   Me, I – if somebody gave me five certain, I’d not really worry about the other four.  (laughter)  But that says something about how the Constitution – how he’s really very convinced that on the Constitutional side it’s OK.

Look, I think that if we study Massachusetts, there’s a lot we can learn about design of these exchanges.54   I’m not enough of an expert and this is not the moment to provide a detailed set of principles.  In general what’s necessary is that the exchanges be designed so as to attract a large pool of people into them so that you’re able to avoid adverse selection.  And that means providing substantial grease in the form of subsidies that gets people in.  I think the way the system is going to be designed is going to make that possible.  But it’s going to need to be monitored, and it’s going to require a great deal of attention.

I’m a little bit nervous about how we find the balance between on the one hand doing what I think we very much want to do as a country, which is allow experimentation in particular states so we can learn what’s best, and on the other hand, allowing complete delegation to states, some of which will seek to find excuses in ways to vitiate the force of the bill.  And that’s the challenge that the administration is going to have to manage going forward in a political environment that is not easy.

M:    Thank you so much to Larry.  Everybody stay close for a minute.  We still have some business to do.  I think you all know what’s coming.  The first order of business is to give Larry a small token of appreciation for his excellent talk and his willingness to engage us on some interesting questions.  So, Larry, this is from us at Harvard Club.  And now I’m going to ask that we all rise and sing – I’m going to wave the reading on the second and third versus of Fair Heart, but ask that we sing the first and last verse of Fair Heart before we conclude.  Thank you all for coming. It’s been a great night, great turn out.  And again, Fair Heart.

1  Catherine Rampell, “SAT Scores and Family Income,” New York Times, August 27, 2009, available at http://economix.blogs.nytimes.com/2009/08/27/sat-scores-and-family-income/.

2  Richard D. Kahlenberg, “Elite Colleges, or Colleges for the Elite?,” New York Times, September 29, 2010.

3  “Conant Enlarges Ideas Limiting College Studies to Best Talent,” Harvard Crimson, March 3, 1938.

4  Vasugi V. Ganeshananthan and Erica B. Levy, “Rudenstine to Resign,” Harvard Crimson, May 22, 2000.

5  Daniel J. T. Schuker, “Harvard Will Be Free for Families Earning Under 60K,” Harvard Crimson, March 31, 2006.

6  Aditi Balakrishna, “New Aid Plan Targets More Affluent Families,” Harvard Crimson, December 11, 2007.

7  Michael Lewis, The Big Short, W.W. Norton & Company, Inc., 2010.

8  Id.

9  Id.

10 Carrick Mollenkamp, Susanne Craig, Serena Ng and Aaron Luchhetti, “Lehman Files for Bankruptcy, Merrill Sold, AIG Seeks Cash,” Wall Street Journal, September 16, 2008.

11 Craig Torres and Bryan Keogh, “Fed Offers GE, Citigroup, Commercial Paper Subsidies,” Bloomberg.com, October 15, 2008, available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ahXpRJ2bFKc0.

12 Peter Baker and Jeff Zeleny, “Obama Repeats a Campaign Staple: Time for Change,” New York Times, October 29, 2008.

13 Eric Rauchway, “Was the New Deal un-American?,” Slate, July 5, 2007, available at http://www.slate.com/id/2169744/.

14 Dow Jones Industrial Average (1900 – Present Monthly), available at http://stockcharts.com/charts/historical/djia1900.html.

15 World Trade Organization; United Nations, Historical Data 1900-1960 on international merchandise trade statistics, April 28, 2009.

16 Bureau of Labor Statistics, Unemployment rate 1948-2011; Pedro Schwartz, The long-term legacy of the 1929 crisis, European Ideas Network Seminar, January 27, 2009.

17 Greg Hitt and Elizabeth Williamson, “Stimulus Bill Near $900 Billion,” Wall Street Journal, January 28, 2009.

18 Graham Bowley, “2 Banks Cited in Stress Tests Find Ready Investors,” New York Times, May 8, 2009.

19 Mike Ramsey and Tiffany Kary, “GM, Chrysler May Face Bankruptcy to Protect U.S. Debt,” Bloomberg.com, February 9, 2009, available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=axtTITF1ogoc.

20 Jonathan Weisman, Alistair MacDonald, and Carrick Mollenkamp. “Obama Hits Resistance at G-20,” Wall Street Journal, April 2, 2009.

21 Bureau of Labor Statistics, “The Employment Situation- February 2011,” March 4, 2011.

22 Jeffrey E. Garten, “America Still Rules,” Newsweek, July 25, 2009.

23 Bureau of Labor Statistics, supra note 21.

24 Dow Jones Industrial Average 2009-2011, available at http://finance.yahoo.com/echarts?s=%5eDJI+Interactive#symbol=^DJI;range=2y.

25 Dow Jones Industrial Average (1900 – Present Monthly), supra note 14.

26 Anatole Kaletsky, “The Benefits of the Bust,” Wall Street Journal, June 19, 2010.

27 Jason Furman, “Recession Prevention: Keynes Was Right,” Brookings, January 28, 2008.

28 Toni Johnson, “Healthcare Costs and U.S. Competitiveness,” Counsel on Foreign Relations, March 23, 2010.

29 Central Intelligence Agency, The World Factbook, available at https://www.cia.gov/library/publications/the-world-factbook/rankorder/2102rank.html.

30 Leslie Scism, “More Go Without Life Insurance,” Wall Street Journal, August 29, 2010.

31 Joseph L. Izzo Jr. and Henry R. Black, Hypertension Primer: Third Edition, American Heart Association, 2003.

32 Scism, supra note 30.

33 Johnson, supra note 28.

34 Central Intelligence Agency, supra note 29.

35 Yunji De Nies, “President Obama Outlines Goal to Improve Graduation Rate in U.S.,” abcnews.com, August 19, 2010, available at http://abcnews.go.com/WN/president-barack-obama-outlines-college-education-goal-university/story?id=11359759.

36 “Youth Indicators 2005: Trends in the Well-Being of American Youth,” National Center for Education Statistics, July 2005.

37 “Reducing America’s Energy Dependence,” National Resources Defense Council, July 2, 2004.

38 James Herron, “Double Blow For U.S. Oil Dependency Hopes,” Wall Street Journal, October 28, 2010.

39 Farnazz Fassihi, “Egyptian Revolution Stirs Raw Emotions in Iran,” Wall Street Journal, February 14, 2011

40 “Headline vs. Core Inflation: The Battle Continues,” Wall Street Journal, May 20, 2008.

41 Id.

42 John Kosar, “A 10-Chart Look at the Latest Inflation Data,” seekingalpha.com, February 25, 2010, available at http://seekingalpha.com/instablog/236879-john-kosar/56134-a-10-chart-look- at-the-latest-inflation-data.

43 Bureau of Labor Statistics, “Productivity and Costs,” March 3, 2011.

44 “Former Treasury Secretary Robert Rubin to Speak at Yale,” Yale Office of Public Affairs & Communications, March 24, 2009.

45 Bureau of Economic Analysis, “Table 6.16D: Corporate Profits by Industry,” January 28, 2011.

46 Dow Jones Industrial Average (1900 – Present Monthly), supra note 14.

47 Simon Lomax, “U.S. Won’t Pass Carbon-Price Law for Power Generators This Year, Reid Says,” Bloomberg.com, September 7, 2010, available at http://www.bloomberg.com/news/2010-09-08/u-s-won-t-pass-carbon-price-law-for-power-generators-this-year-reid-says.html.

48 David Brooks, “Cleaner and Faster,” New York Times, January 29, 2009.

49 Bureau of Labor Statistics, supra note 21.

50 Mark Brown, “Europe Sovereign Default Insurance Cost Near All-Time High,” Wall Street Journal, December 30, 2010.

51 Jon Clifton and Jenny Marlar, “Worldwide, 40% Are Employed Full Time for an Employer,” Gallup, January 19, 2011.

52 Emily Kaiser, “U.S. Inflation is Climbing, but a Rerun of the 1970’s is Unlikely,” New York Times, June 3, 2008.

53 Laurence H. Tribe, “On Health Care, Justice Will Prevail,” New York Times, February 7, 2011.

54 Lea Winerman, “In Legislation, New National Health Exchange Emerges,” PBS.org, July 23, 2009.

Prophecies of American decline will prove to be self-denying once again

/in

Herzliya Conference

February 6, 2011

It is an enormous honor to be part of this conference from which I have already learned a great deal.  One of the things I have learned is that Carlyle got it wrong when he called economics the dismal science.  That term should instead be applied to national security studies.

And this is a remarkable collection of people gathered here. Talking about economics in the presence of my teacher, Stanley Fischer, is daunting.  Talking about its relation to national security in the presence of my Obama administration colleague, former National Security Advisor Jim Jones, is daunting.  And talking about anything in the past in the presence of my Harvard colleague Niall Ferguson is daunting as well.  But I shall persevere.

Questions have been raised that are on everybody’s minds.  And indeed there is much to worry about.  But there always has been.  Fifty years ago, I was six years old.  Every two weeks my school had a drill where we all learned to crawl under our desks to protect against a possible bomb attack.  At that time, President Kennedy believed that the United States economy would be surpassed by the Soviet Union by the mid 1980s – a belief that was supported by the leading economics textbook of the day.1

Such prophesies of American decline and consequent loss of global power proved wrong in the 1960s, and they have proved wrong again and again.  They were wrong in the early 1970s when the collapse of the Bretton Wood system, Vietnam, rising inflation, and Watergate led to loss of confidence in America.  They were wrong in the late 1970s when oil price spikes, Iranian hostages, and record interest rates led economists to decry our zero sum society,2 and an American President to declare a crisis of the national spirit.3   They were wrong in the late 1980s and early 1990s when it became a cliché contained in every issue of the 1991 Harvard Business Review that the Cold War was over and that Japan and Germany had won.4

I believe that prophesies of America’s decline today, rather than being self-fulfilling, will again prove self-denying, spurring the renewal that guarantees their falsity.  America’s economy and the global economic situation in the years ahead will permit us to lead.  America’s interest in prosperity and security will compel us to lead.  And perhaps after exhausting some of the alternatives, America will find the will to lead.

The dynamics of renewal are underway in ways that may not be fully visible, but the historians will clearly mark.  Consider first the dynamics of economic recovery. Others have spoken, powerfully, to the financial crisis that we have just been through.  The stock market declined by more between October of 2008 and March of 2009 than it did in the six months following September of 1929.5   The same can be said for world trade.6  The same can be said for employment in the United States.7

Fortunately, we have learned from the Depression and we have learned from the ample history of financial crisis since that time.  There was no reliance in the United States and in the many countries that followed the advice of the United States on the self-stabilizing forces of the market in time of emergency.  Instead, all the pools of policy were mobilized on an unprecedented scale.  Fiscal measures, monetary expansion, support for financial institutions, and direct provision of credit by government public investment, were mobilized to an unprecedented extent, to be sure.8

Problems that were not made in a day or a month or a year have certainly not been resolved yet.  Unemployment in our country, in other parts of the industrialized world, remains far too high.  And will for a substantial time to come.  But the American economy is now on the mend and approaching escape velocity.

For the first time in five years I am more optimistic than the consensus forecast, and expect growth to exceed 3.5% this year.  Unemployment has declined by .8 of a percentage point in the last two months alone.9   Corporate profits have increased by more than 60% in the last two years,10 despite business concerns about the direction of public policy.  And those who invested alongside President Obama’s recovery program have earned more than an 80% return on the US Stock Market over the last two years.11 Taxpayers have now received essentially all the emergency funds extended to financial institutions backed, and in many cases have earned a substantial profit.12

What is crucial is that we maintain the momentum of this recovery.  There are those who believe that the right focus at such a time shifts immediately to inflation.  And with the developments in commodity markets we surely do need to be vigilant with respect to what happens at the price level.

But with unemployment still in excess of 9%,13  with substantial capacity unutilized in American business,14  with declining wage cost,15  and with robust productivity performance,16  this is not the time to alert for a lurch to inflation alarmism.  It is a time to maintain a focus on ensuring that there is the demand that is necessary to assure growth and demand for exports, which is why President Obama has a goal.  A goal in which we are ahead of track, of doubling US exports over a five-year period.17   Demand for investment, something that is difficult to achieve in standard forms of investment when there is excess capacity, but is readily available when there is technological improvement.  After all, we have three computers in our basement, but I just bought an iPad.

The economy is recovering.  And with that recovery is coming what is the cheapest form of stimulus in any economy, an increase in confidence.   And with that recovery will come important changes in psychology.

Now to be sure, only part of the concern about America’s future turns on this financial crisis and the questions it raised about capitalism.  The concern is also present that the United States has lost its capacity to lead, that the United States is a declining share of the global economy and will therefore have inevitably diminishing influence.

What I found striking in the GDP chart presented was actually the robustness of the American position.  US GDP was very close to 50% of global GDP at the end of the Second World War.18  Over the subsequent 45 years, it fell rather dramatically from 50% to, according to the chart presented, 23%.  Yet that is an event that we celebrate.  We celebrate the Marshall Plan.  We celebrate the reintegration of the defeated powers of Europe, of Japan, into the global economy.  And what is striking is that having fallen from 50% to 23% between World War II and 1990, the division is strikingly small from 23% to 20% in the 20 years between 1990 and 2010.19

It was taken as a given 20 years ago that the other industrialized countries would catch up and would ultimately surpass the United States.  And yet the reality is that the United States pulled away from the other industrial countries.  Why?  There are many parts of it, but I suspect it is the capacity that the United States had had, a capacity that I might say that I believe your country shares, to adapt to the knowledge and information economy.  To an extent that I think is not fully appreciated, just as the world went through a transformation from an agricultural economy to an industrial economy, it is now going through a transformation from an industrial economy to a knowledge economy.

Less than 5% of the workers in the United States now work as production workers in US manufacturing firms.20   That is roughly comparable to where agriculture was 40 years ago.21   Instead, the major driver of value is increasingly knowledge.

I remember going to Russia at President Clinton’s request to speak about economic policy with the then Russian National Security Advisor.  And I droned on about market forces and incentives and it was clear that he found nothing that I was saying to be of any interest to his situation.  And then I said, and this did get his attention – I said, you know something, in the United States the Microsoft Corporation is worth more than the sum of all the automobile companies, all the steel companies, and all the aerospace companies multiplied by a factor of 1.5.  And he said that couldn’t be right, and I showed him the appropriate table.  And he didn’t know quite what to make of it, but he decided there really was something going on with respect to information technology.

Being one of the two countries in the world, Israel being the other, where you can raise your first $100 million before you buy your first suit, gives a nation a powerful competitive advantage in a knowledge economy.  And we have benefited from that.  Benefited from that in pure economic terms.

General Motors now employs less than a 150 thousand people.22  There are 800 thousand people engaged as their job in transacting on eBay.23  And we have benefited in a much broader way.

Six years ago Mark Zuckerberg was a Harvard Junior who did not go to class.  Today Facebook has 600 million users around the world,24  fifty percent of whom were on Facebook yesterday25 for an average of a half an hour. And Facebook is worried about rising competitors who might displace it from its position of strength.  As one thinks about the future of nations and their economies, think about that.

Another challenge has been raised with respect to the American economic position.  And that is the level of American debt.  The first thing to say is that if you as a nation have the opportunity to make investments in companies like Facebook, if you have the opportunity to make investments like the renovation of the American infrastructure, that is not where it should be, and somebody is prepared to lend you money for 30 years in your own currency at 3.5%, there are less rational things to do than to take advantage of that opportunity to borrow. I, for one, would rather live in a country that capital is trying to get into, than a country that capital was trying to get out of.

Now for sure, the US is doing the right thing by assuring that there is public investment, that there is public borrowing to support spending, in the current cyclical moment when borrowing by our households has collapsed, and when borrowing by your businesses has sharply declined.

But our fiscal position is not sustainable without further adjustment.  There are differing estimates as to just how large that adjustment is.  But a consensus estimate would be that adjustments are needed of between 2% and 3% of GDP if the US debt to GDP ratio is to be returned to a declining path.26

How much is that?  It’s about a quarter of the investment necessary in the European countries that are in serious trouble. It is about a third of the magnitude of the fiscal adjustment accomplished by the United States during the Clinton years.27  And speaking under the authority of two former leaders of the IMF, I can say that it is a relatively limited adjustment by historical standards.

We have the room to make that adjustment.  The most important determinant by far of the US fiscal position is what’s happening on healthcare costs.  And with US healthcare costs running at 17% of GDP, 50% more than they are in any other major country in the world,28  we have the capacity to realize economies in healthcare.

Frankly, it was inconceivable that that capacity would be realized as long as 50 million people were without health insurance, because any move to cost cutting and economy would be certain to fall on those unfortunates.  We now have a framework in place, to be sure not a self-executing framework, but a framework in place, that offers the prospect for reductions in healthcare spending, and its trend growth.

We have, for the first time, bipartisan recognition of the reality that our retirement programs will need to be adjusted for the fact that people are living longer.29   And we have, in a little remarked, but fundamentally important development, a bipartisan recognition that so-called tax expenditures, subsidies contained in the tax code,30 are a kind of expenditure, rather than a kind of tax.  And therefore, the alleviation, the removal of those subsidies is not properly thought of as a tax increase, but as an expenditure reduction.

All of these building blocks, I believe, suggest that as the economy recovers, as the government’s borrowing is no longer a supplement to lagging private borrowing, but a competitor for private borrowing, the political consensus for fiscal action will, I am confident, emerge.  And as that development emerges, this too, will be a further contributor to US confidence.

More and more of the economy is becoming more and more anchored in knowledge and information technology in which the fastest rates of growth are recorded.  This suggests the likelihood not of the exhaustion of growth opportunities, but the real and plausible prospect for the acceleration of growth opportunities.

Now a third important concern was raised, and it is a crucial question in looking at the global economy.  Which is the rise of emerging markets.  Now to be sure, those nations that had been seen as likely to surpass the United States, the Soviet Union in the ‘60s, the other industrial countries in the late 1980s and the early ‘90s, no longer seem the economic threats that they once did.  And no one can fail to recognize the significance of what is happening in emerging markets in general, and in China where a fifth of humanity lives in particular.

Here’s one way to think about it.  On the most generous rating of the statistic, standards of living in cutting edge societies doubled between the time of Pericles in Ancient Greece and London in 1800, 2300 years.31  Standards of living and the period of the most rapid US economic growth doubled in a single human life span,32 then about 45 years around the beginning of the 20th century.33   And growth is preceded in China for the last decade at a rate where standards of living double in a single decade.34

China has emerged as a major force in the global economy, and it will be a central task for all nations to assure that that is an opportunity and not a burden.  But again, I ask you, is the United States poorer because Germany and Japan recovered?

I live in the city of Boston in the United States.  The south of the United States has recovered on a substantial scale over the last 40 years, driven by the spread of technology, driven above all else by the presence of pervasive air conditioning35 that has made it a far more attractive place to locate and produce.  Has that made Boston poorer, or has that made Boston richer?  I think it has made Boston richer.

There is no reason why the success of emerging markets need threaten the prosperity of those who are in industrial countries.  At the same time I think it is easy to reach judgments that look rather foolish in retrospect with respect to countries that have grown rapidly recently.

One of the largest differences between what economists know and what most observers of economies believe, is that extrapolative forecasting doesn’t work.  You can array all the countries in the world, and you can look at their growth rate in one decade, and you can look at their growth rate in the next decade, and you will find that everybody thinks that the countries that grew very fast in the last decade are sure to grow very fast in the next decade.  And then you can look decade after decade, the 60s, the 70s, the 80s, the 90s, the first decade of the 21st century, what that correlation is.  And it is very close to zero.  And so we need not to assume that past is necessary prologue36– that a society beset by environmental problems, rising expectations, problems of governance and corruption, and financial bubbles will, with certainty grow in the future as it has in the past.

And if you remember only one thing from what I say, remember this.  Look in on those most recent IMF statistics or the CIA’s World Fact Book, or any of the people who access these matters.  Look at Chinese standards of living.  And then go back and calculate at what moment America had the same standard of living.  There are different ways of doing the calculation, and you can do it at purchasing power parity, or you can do it using the exchange rate.

If you work very hard to do it in a way that flatters China, you will conclude that China has the standard of living that United States had in 1930.  If you do it in a more straightforward way, you will conclude that China has a standard of living like that in the United States at the beginning of the 20th century.37

Now to be sure there are all kinds of problems of measurements, and China has all kinds of capacities starting with missiles and weaponry that nobody could have dreamed of in the 20th century.  But to suggest that this is a transcendent threat to America’s prosperity or America’s capacity to have substantial influence in the world is, I think, quite unlikely.

We saw this in a way in the last three weeks.  People were very concerned with what was happening on the street in Egypt.  They were very concerned with what was happening within the Egyptian military.  And they were very concerned not with what the reaction was in Europe, or in Beijing, or at the United Nations, but what the reaction was in Washington.  And Washington saw itself as having an obligation to respond.38

So I would suggest to you that those who believe that the United States does not have the capacity, the economic strength to respond to global events, may be making a very serious mistake.  There is still the question, and it is perhaps the most fundamental one of all of whether or not the United States, even if it has the capacity, has the will it has had in the past to lead.

To be sure the last was not an easy decade for our country.  It was a decade of hubris abroad followed by humbling through the financial crisis at home.  And therefore there is the fear that gridlock at home, and disengagement abroad will be what follows.  Those are real risks.  Those are the things that people prophecy.  Prophecies that I believe will be self-denying.

What about gridlock?  You know, you can argue – people surely do and will for a long time, argue about the substance of the policies President Obama has pursued domestically. What you cannot argue with is that the first two years between 2009 and 2010 of his administration were the most productive period for the production of consequential legislation in the last 40 years.

It was expected that following the election, an election in which the President’s party surely did not do as he would have wished, that there would then be gridlock and it would be impossible for anything meaningful to happen in what we always call the Lame Duck session of our Congress.  And yet substantial fiscal legislation that was important to the upward revision of the economic forecast that I have described was passed.

The most vexing issue in American politics, one of the most vexing social issues in American politics, the question of gay soldiers in the military was resolved.39  And the most important arms control agreement in well over a decade was passed.40   And this in what was regarded as a Lame Duck session.

Some suggest that that was the last hurrah for American policy and hold out the protest that with divided government, the Republican leadership in one party, nothing important will happen.  This is a hypothesis that has been carefully studied by political scientists.  And if anything, the evidence suggests that because doing painful things requires more than one hand on the dagger, that periods of divided government are more productive in terms of the ability to make painful adjustments in our national path.41

So, yes, the concern, the fear, the challenge, are appropriate.  But gridlock is, I believe, not the right prediction for the years ahead.

What about the suggestion that United States will turn inwards and not take its global responsibilities seriously in the years ahead?  Surely this judgment will be something that will depend upon how the economy fairs.  If, as I’ve explained, the economy recovers, if the economy expands, America’s self-confidence and its capacity for global action will be enhanced in the years ahead.

There are some things that Americans do understand.  Terror has no address, but it does have well understood roots in depravation and frustration – and that policies that address that frustration and give all a chance to participate in the global economy and that support the continuous openness of markets are availing.

If you think back over the last two years, what is remarkable is not that the US-Korea Free Trade agreement has not passed yet.42   What is remarkable is that after six months when world trade declined more rapidly than it ever has, with the worst economic downturn, with the first year of global GDP decline since the Second World War,43 that there has been essentially no systematic move towards protection.  The global markets have remained open.  What is remarkable is that the openness brought about by improvements in communication and transportation technology that dwarfs what’s achievable through legalistic agreements has actually been allowed fully to continue.

Complexity is necessary for prosperity, but it also produces vulnerability.  Nowhere is this truer than in the energy area.  A good rule in life in forecasting financial crisis, in forecasting developments in the national security and political sphere, and I would suggest with respect to technology, is that as my late teacher Rudi Dornbusch used to say, things take longer to happen than you think they will.  And then they happen faster than you thought they could.

And I suspect that that may happen in the energy area.  We have been vowing progress on reduced dependence on oil and in particular Middle Eastern oil for the better part of half a century now.  The combination of most important fossil fuel development in 40 years, pervasive discoveries including in the United States of natural gas, substantial technical changes on the energy use side,44 particularly with respect to the use of electricity and natural gas in vehicles, and progress in a variety of new technologies on the production side leads me to expect that 15 years from now people who look at the oil dependent statistics are going to be quite surprised by the progress that has been made.

And finally there is an awareness, and an awareness that my former colleagues in the administration have very deeply – and I think it is an important awareness but one that sometimes complicates the interpretation from the outside of what is being done – that power is like capital.  Invested prudently it grows.  And invested unwisely it is lost.

The most important difference between negotiation and the achievement of objectives in the private and in the public realm is this – in a private negotiation no aspiration is unacceptable.  The more ambitious the aspiration the better the starting point for the negotiation.

It is very different when you negotiate in the public realm.  An excessively ambitious aspiration can sacrifice legitimacy.  The quality of outcomes is judged not just by the outcome, but the difference between the outcome and the stated aspiration.  And that is why the management is so very difficult.  And it is why those who wish to enhance their power choose which of the many objectives that they desire it should be devoted towards.  I believe that is the approach the United States has taken and will continue to take in the future.

Now to be sure, I have sketched the optimistic view of the future.  Perhaps in some places I have substituted prescription for description.  And no one can know with confidence what the future will bring.  And there can be no certainties.

But I would suggest this aspect of the United States stands out and it is another respect in which we are bound to our country – we are a fractious democracy.  Fractious democracies are not always satisfying to watch.   They sometimes move too slowly.  But they have a very important virtue.  A virtue that is increasingly important in an ever more complex and an ever more changing world.  And that virtue is resilience.  And it is the resilience of American society that is the reason that all those fears that people had when I was six years old huddled under a desk were wrong.  And it is the reason why I believe most of the prophecies of American decline will prove to be self-denying once again.

Thank you very much.

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

2 Rich Karlgaard, “Zero-Sum Fallacies,” Forbes.com, July 23, 2007 12:00 AM.

3 Jimmy Carter, Speech: Crisis of Confidence, July 15, 1979.

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

5 Dow Jones Industrial Average (1900 – Present Monthly), available at http://stockcharts.com/charts/historical/djia1900.html.

6 World Trade Organization; United Nations, Historical Data 1900-1960 on international merchandise trade statistics, April 28, 2009.

7 Bureau of Labor Statistics, Unemployment rate 1948-2011; Pedro Schwartz, The long-term legacy of the 1929 crisis, European Ideas Network Seminar, January 27, 2009.

8 Supeed Reddy, “The New Old Big Thing in Economics: J.M. Keynes,” Wall Street Journal, January 8, 2009.

9 Bureau of Labor Statistics, “The Employment Situation- January 2011,” February 4, 2011.

10 Bureau of Economic Analysis, “Table 6.16D: Corporate Profits by Industry,” January 28, 2011.

11 Dow Jones Industrial Average 2009-2011, available at http://finance.yahoo.com/echarts?s=%5eDJI+Interactive#symbol=^DJI;range=2y.

12 David Cho, “U.S. take if it sells its Citi stake to settle cost of bailout: $8 billion,” Washington Post, March 27, 2010.

13 Bureau of Labor Statistics, supra note 9.

14 Federal Reserve, Statistical Release: Industrial Production and Capacity Utilization, G.17, February 16, 2011.

15 Bureau of Labor Statistics, Employment Cost Index 2001-2010, available at http://data.bls.gov/pdq/SurveyOutputServlet?data_tool=latest_numbers&series_id=CIU1010000000000A

16 Bureau of Labor Statistics, Economic News Release: Productivity and Costs, Forth Quarter and Annual Averages 2010, Preliminary, available at http://www.bls.gov/news.release/prod2.nr0.htm.

17 Helene Cooper, “Obama Sets Ambitious Export Goal,” New York Times, January 28, 2010.

18 Deanne Julius, “US Economic Power: Waxing or Waning?”, Harvard International Review, August 23, 2006.

19 World Economic Outlook, “US GDP based on PPP share of world total,” EconStats, available at http://www.econstats.com/weo/V012.htm.

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

21 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.

22 Bill Vlasic & Nick Bunkley, “The Last Holdouts Cast Their Lot With G.M.,” New York Times, May 20, 2009.

23  John Kador, “10 Tips for Bootstrapping Your Technology,” Inc., June, 3, 2010, available at http://www.inc.com/guides/2010/06/tips-for-bootstrapping-your-technology.html.

24 Jessica Guynn, “Facebook hits 600 million users, executive says,” Los Angeles Times, January 24, 2011.

25 Facebook.com, Pressroom: Statistics, available at http://www.facebook.com/press/info.php?statistics.

26 Ben S. Bernanke, Speech: The Economic Outlook and Macroeconomic Policy, February 3, 2011.

27 Per Gunnar Burgland & Matias Vernengo, “A Debate on the Deficit,” Challenge, November/December 2004.

28 Toni Johnson, Healthcare Costs and U.S. Competitiveness, Counsel on Foreign Relations, March 23, 2010.

29 Jonathan Weisman and Damian Paletta, “Majority of Panel Backs Deficit Plan,” Wall Street Journal, December 4, 2010.

30 Mark Feldstein, “The ‘Tax Expenditure’ Solution for Our National Debt,” Wall Street Journal, July 20, 2010.

31 John Maynard Keynes, Essays in Persuasion, New York: W.W.Norton & Co., (1963)

32 Richard H. Steckel, “A History of the Standard of Living in the United States,” available at http://eh.net/encyclopedia/article/steckel.standard.living.us.

33 Laura B. Shreshta, Life Expectancy in the United States , CRS RL32792, August 16, 2006.

34 Nin-Hai Tseng, “China is richer, but most Chinese are still poor,” CNNMoney.com, February 17, 2011; Central Intelligence Agency, The World Factbook, available at https://www.cia.gov/library/publications/the-world-factbook/geos/ch.html.

35 Larry J. Griffin and Don Harrison Doyle, The South as an American Problem, University of Georgia Press (1995)

36 Lant Prichett, “Understanding Patterns of Economic Growth: Searching for Hills among Plateaus, Mountains, and Plains”, The World Bank Econ Rev (2000) 14(2): 221-50.

37 Steckel, surpa note 32; Tseng, supra note 34; Central Intelligence Agency, supra note 34.

38 Hans Nichols and Mike Dorning, “Obama’s Words Put to Test in U.S. Response to Egypt Anti-Mubarak Uprising,” Bloomberg, January 31, 2011.

39 Nathan Hodge, “Senate Passes Bill to Lift Military Gay Ban,” Wall Street Journal, December 18, 2010.

40 Julian E. Barnes and Naftali Bendavid, “Senate Ratifies Nuclear-Arms Pact,” Wall Street Journal, December 23, 2010.

41 David R. Mayhew, Divided We Govern, Yale University Press (1991).

42 Elizabeth Williamson, “U.S.-Korea Pact Hinges on Autos,” Wall Street Journal, December 3, 2010.

43 Central Intelligence Agency, The World Factbook, available at https://www.cia.gov/library/publications/the-world-factbook/geos/xx.html.

44 Angel Gonzalez, “Exxon Sees Burgeoning Demand for Natural Gas,” Wall Street Journal, January 27, 2011.

On Growth

/in

OnGrowth“On Growth,” Policy Network Publication

Britain risks a lost decade unless it changes course

/in

September 16, 2012

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

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

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

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

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

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

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

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

The case for research

/in

“The case for research,“ PROTO Magazine – Massachusetts General Hospital

America’s state will expand whoever wins

/in

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.

Doing Right by our Children

/in

“Doing Right by our Children,“ Excerpted from Remarks at the Commonfund Forum 2012

Land of Opportunity Can Fight Inequality

/in

July 15, 2012

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

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

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

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

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

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

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

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

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

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

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

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

Time to act: Euro collapse would define our era

/in

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.

Look beyond interest rates to get out of the gloom

/in

June 3, 2012

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

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

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

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

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

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

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

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

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

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

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

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

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

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