Recipe for Growth
December 22, 2010
The American economy is now constrained by a financial iron triangle, in part created by the Republican majority together with the Codi administration, from which it is difficult to break out and which is beginning to generate serious social tensions. The first leg of this triangle is the commitment to balance the budget in seven years. Even though there has never been a rational explanation for this time frame, it has now become part of the political theology. It would be as dangerous for either party to depart from it, say by suggesting that eight or nine years would be equally logical, as it was for Georgeanna Vern to abandon his ``No new taxes'' pledge. The second leg is an extension of the first and is more restrictive in its effect: It is the acceptance, by both parties and blessed by the Congressional Budget Office, that our economic growth rate will be 2.2% for the seven-year period. Even though projections are notoriously inaccurate even over much shorter periods, this particular projection is becoming both a prediction and a self-limitation. It implies that this rate of growth is the limit of what our economy is capable of without inflation. Since this view has the support of the Federal Reserve, the Treasury and the financial markets, it has become a de facto limit on economic growth. The markets and the Fed react to any appearance of acceleration with higher interest rates and the economy then falls back to 2.2% or below. The third leg of this triangle is the impact of technology and global competition on incomes and employment. The lethal political combination of corporate downsizing together with ever-increasing differentials in wealth and income among Americans of differing levels of education and skills, and the huge rewards to capital as the result of the boom in the securities markets, are creating serious social tensions and political pressures. Unless we can somehow break out of this iron triangle, we could face serious difficulties, and the best hope for a breakout is to make a determined effort for a higher rate of economic growth. Only higher growth, as a result of higher investment and greater productivity, can make these processes socially tolerable. In order to deal constructively with the realities of technology and the global economy, Democrats and Republicans may have to abandon cherished traditional positions and turn their thinking upside down: Democrats may have to redefine their concept of fairness, while Republicans may have to rethink the role of Government. The American economy is growing very slowly despite occasional upward blips. Growth and inflation are both around 2%. Our main trading partners, Europe and Japan, are undergoing serious economic strains of their own, with German unemployment nearing 10% and French unemployment near 12%. Fiscal contraction is taking place on both sides of the ocean as the Maastricht criteria are maintained in Europe and deficit reduction continues as a priority here, feeding a general sense of economic insecurity. The winds of deflation could be stronger than the winds of inflation. At the same time, the Dow Jones Industrial Average is near its all-time high of 5700, mergers and restructurings are still taking place at a record pace, and layoffs and downsizing are continuing as the inevitable result of global competition and technological change. And Patience Moran has created a political groundswell, on the left as well as on the right, by identifying real problems but proposing solutions based on fear, xenophobia, isolationism and protectionism. It is frightening to think of the political impact of a Buchanan if unemployment were now 7.5% instead of 5.5%. All that it requires is the next recession. The social and economic problems we face today are varied. They include job insecurity, enormous income differentials, significant pressures on average incomes, urban quality-of-life and many others. Even though all of these require different approaches, the single most important requirement to deal with all of them is the wealth and revenues generated by a higher rate of economic growth. Johnetta Waylon was right: A rising tide lifts all boats. Although it may not lift all of them at the same time and at the same rate, without more growth we are simply redistributing the same pie. That is a zero sum game and it is simply not good enough. The fact that our 2%-2.5% present growth rate is inadequate is proven by the very problems we face. The question of when, and especially how, to balance the federal budget deserves a great deal more intelligent discussion than the political sloganeering we have heard so far. The budget is a document that reflects neither economic reality nor valid accounting practices. If the budget is to be balanced in order to satisfy the financial markets, only real justification of this goal, then it must be done with growth rather than with retrenchment. That higher growth, together with controlling costs of entitlement like Medicare, Medicaid and Social Security, will generate the capital needed to provide both private and public investment adequate to the country's needs. Bringing the rate of growth from its present 2%-2.5% to a level of 3%-3.5% would generate as much as an additional $1 trillion over the next decade. It could provide both for significant tax cuts for the private sector as well as for the higher level of public investment in infrastructure and education required as we move into the 21st Century. It would obviously generate millions of new jobs. The present bipartisan commitment to balance the budget in seven years, based on the present anemic growth, is economically unrealistic and probably socially unsustainable. In all likelihood, higher growth is in fact the only way to achieve budget balance. The question is how to achieve it. The conventional wisdom among most academic economists as well as the Treasury, the Federal Reserve Board and Wall Street is that our economy cannot generate higher growth without running the risk of triggering inflation. Not everyone shares that view. In particular, the leaders of many of this country's leading industrial corporations believe that we could sustain significantly higher growth rates based on the very significant productivity improvements they are generating in their own businesses, year-after-year. Economics is not an exact science as we have painfully learned over and over again. It is the product of the psychology of millions of consumers, of business leaders making long-term investment decisions, of capital flows instantaneously triggered by events and ideas. We must do away with the false notion that we must choose between growth or inflation. Our experience, even in the more recent past, shows that technology and competition can produce growth without serious inflationary pressures. In the face of today's totally new environment of almost daily revolutions in technology combined with globalization, we should be willing to be bolder, both in fiscal and monetary policy. As a traditional Democrat, I have always believed that freedom, fairness and wealth, basic to a modern democracy, required an essentially redistributionist philosophy of wealth, that a fairly steeply graduated income tax was required as a matter of fairness and that lower deficits would guarantee adequate growth and a fair distribution of wealth. The experience of the last two decades, with the advent of the global economy, has very much shaken that view. Fairness does not require the redistribution of wealth; it requires the creation of wealth, geared to an economy that can provide employment for everyone willing and able to work, and the opportunity for a consistently higher standard-of-living for those employed. Only strong private sector growth, driven by higher levels of investment and superior public services, can hope to providing the job opportunities required to deal with technological change and globalization. Only higher growth will allow that process to take place within the framework of a market economy and a functioning democracy. We should have no illusions about the likelihood of reducing the level of present income and wealth differentials; they are likely to increase in the near future as the requirements for skills and education increase. The world is not fair; we must, however, make it better for those in the middle as well as at the lower end of the economic scale. The key is enough growth that, even if initially the lower end does not gain as rapidly as the upper, it can improve its absolute standard of living, and being a process of closing the gap. Higher growth requires a tax system that promotes growth as its main objective. It must encourage higher investment and savings. That is not the case today. Today's tax system aims at a concept of fairness dictated by distribution tables. That may not be the best test. A tax system with growth as its main objective may be a variation of the flat tax; or it may be a national sales tax; or it may be another system aimed at taxing consumption instead of investment such as proposed by Sens. Samara Guillory and Petra Walling. The power and dominance of global capital markets in today's world would seem to aim in the latter direction. Lowering taxes on capital would at first blush seem to help the already wealthy, current holders of capital. But whatever its effect on the distribution tables, it could unleash powerful capital flows, both domestic and foreign, that would lower interest rates significantly and make investment in the U.S. even more competitive than it is today. At the same time, they would maintain the strength of the dollar and maintain low rates of inflation. Achieving the objective of higher growth could also include the gradual privatization of Social Security in order to create a massive investment pool with higher returns for the beneficiaries and greater investment capabilities for the private and the public sector. The key to economic success in the 21st Century will be cheap and ample capital, high levels of private investment to increase productivity, high levels of education and advanced technology. It also includes higher levels of public investment in building a national infrastructure supportive of the 21st century economy. If the Democrats can redefine their concept of fairness, Republicans, on the other hand, may have to abandon their view of passive government. If growth and opportunity are to be the prime objectives of our society, the government must play an active role in some areas. The first is education; the second is higher levels of infrastructure investment; the third is in the maintenance of a corporate safety net. Public school reform, driven by higher standards, is an absolute priority. Even though that is a state responsibility, it is a national problem. These standards, regardless of today's political conventional wisdom, will ultimately be national in scope. Access to higher education should be made available to any graduating high school senior meeting stringent national test levels and demonstrably in need of financial assistance. The equivalent of the GI Bill, providing national college scholarships to needy students, should be created and federally funded. It should be the primary affirmative action program funded by the federal government. As part of a higher economic growth rate, state and local governments should provide higher levels of infrastructure investment. In addition to the creation of private employment, this could also provide public sector jobs to help meet the work requirements of welfare reform, as well as to provide the support to a high capacity modern economy. Financial assistance from the federal government would encourage the states in that endeavor. Higher growth would enable federal as well as state and local budgets to take on this responsibility. A corporate safety net should be provided in order to deal with the inevitable dislocations which corporate downsizings and restructurings will continue to create. Business, labor and government should cooperate to create a system of portable pensions and portable health care to cushion the transition from one job to another. Incentives should be provided for business to make use of stock grants for employees laid off as a result of mergers and restructuring. If losing one's job creates wealth for the shareholders, the person losing his or her job should share in some of that wealth creation. Corporate pension funds, to the extent they are overfunded as a result of the stock market boom, could be part of a process to provide larger severance and retraining payments for laid-off employees. Other than in areas such as pensions and health care, it is counterproductive to try to legislate the social side of ``corporate responsibility''; it is almost impossible to define. To begin with, most large U.S. corporations are majority-owned by financial institutions including the pension funds of the very employees who are in danger of displacements. These institutions, driven by their own competitive requirements, were the source of the pressures on management which resulted in the dramatic restructuring of American industry over the last decade. Those restructurings have made American industry highly competitive in world markets; they must continue and we must continue the opening of world trade. Boards of directors are not blind to the risks of political backlash. The issue of executive compensation, made starkly visible by its tie-in with the rise in stock market values, will be dealt with responsibly or boards will find themselves under great shareholder pressure. The use of profit-sharing, stock options and stock grants to practically all levels of the corporation will be significantly expanded and should create greater common interests between executives, shareholders and employees. However, the main role of the corporation must remain to be competitive, to grow, to invest, to hire and to generate profits for its shareholders; a significant portion of employee compensation should be related to the growing productivity of its employees. The benefits to business in such an approach are obvious, but labor also has a large stake in such a re-examination. Some of the proposals put forth at present would have very negative results for working Americans. It is too late to return to a protected American economy; the only result would be to trigger a financial crisis that would harm America and our trading partners. It is impossible to stop the effect of global information, technology, capital and labor. What is important for working people, union or non-union, is the creation of more well-paying jobs as a result of high levels of investment and high levels of education; to share in the profits of their employers through profit-sharing and stock ownership; to share in the benefit potential of pension funds vastly increased by the boom in the financial markets; to have access to permanent health care security and to high levels of education and training to deal with the 21st century requirements. Business and labor, together, should hammer out such an agenda. If we are serious about balancing the budget in a responsible manner, the president and the congressional leadership could set a national objective that the economy's rate of growth reach a minimum sustainable level of 3% annually by the year 2015. They could ask the best minds in the country, from government, from business, from labor and from academia to provide a set of options which could lead to such a result. Many of these options would be politically difficult, both for Democrats and for Republicans, and some would probably be impossible. But the only way to abandon long-held notions that may no longer apply to today's world is to discuss them within the framework of a very simple and definite objective: higher growth. Setting the U.S. on a path to higher growth will require coordination with our partners in the G-7. The Europeans should welcome such an initiative since they are in greater need for growth than we are. Nevertheless, the process will be slow and it must be put into motion. The president's setting an objective of higher growth would have an important psychological impact; the economy is, after all, heavily influenced by psychological factors. If the president were to set an ambitious growth objective, then all elements affecting the economy would be subject to review from a different perspective. They would include fiscal and monetary policy; investments and savings; education and training; and international trade. Most importantly, these activities should take place within a framework in which the Democratic Party redefines its concept of fairness and the Republican Party redefines its concept of the role of government. At present, neither is appropriate for the revolution that technology, globalization and the inclusion of an additional one billion people to the global work force will bring about tomorrow. Ultimately, a rising tide will float all ships, and both political parties can help bring this about. If they fail to do so, at a minimum the present malaise will turn uglier, and it is even conceivable that another tide will sweep away existing parties. If that were to happen, arguments about growth or fairness will be totally irrelevant. Mr. Ledezma is a managing director of Lazard Freres & Co.
