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The world’s developed economies, of which the United Statesis by far the largest and systemically most important, face a range ofdifficult political and social choices. President Barack Obama’s proposed USbudget acknowledges and addresses those choices and tradeoffs directly andfully for the first time in the post-crisis period.
Obama’s proposal is an important,honest, and politically courageous document. The debate that follows willlargely determine whether the US shifts toward a strong, inclusive, andsustainable pattern of growth and employment, and how the burden of moving tosuch a path will be shared by Americans of various ages, educational levels,incomes, and wealth.
We know that powerfultechnological and global market forces have reduced dramatically the number ofroutine professional and blue-collar jobs, shifted employment options for themiddle class toward the non-tradable side of the economy, and channeled growth innational income toward capital and high-end employment, with stagnating incomeelsewhere. Job creation remains weak, and employment continues to diverge from growth.
These trends cannotbe blamed entirely on poor policy choices or shortsighted government. Theyarise mainly from an increasingly integrated global economy’s shiftingtechnological landscape; but they have been exacerbated by a systematic pattern ofpublic-sector underinvestment.
The lesson from manydeveloped and developing countries is that underinvestment in infrastructure,human capital, institutions, and the economy’s knowledge and technology basereduces long-term growth. Short- and medium-term growth can be sustained for awhile by substituting public and private debt for investment – that is,borrowing against future income and consumption. But this approach establishesa self-limiting pattern, because balance sheets are damaged, demand falters, and expectationshave to be adjusted downward.
This brings us to thechoices that Obama’s budget embodies.First there is the issue of how fast to reduce government deficits and theaccumulation of public debt. Sudden fiscal contraction would reduce domesticaggregate demand faster than the economy’s deleveraging and structural shiftscould replace it, thereby killing off growth and hiring, with adverse feedbackeffects on budget deficits. But delaying the debt reckoning for too long wouldundermine confidence in the US government’s capacity for fiscal discipline.
Deficits have to fallwithin a time horizon of 5-10 years. The alternative is either a sovereign-debtcrisis, followed by a destructive spike in borrowing costs, or a growing burdenfor subsequent generations of taxpayers.
In an ideal world,where compromise is unnecessary, US fiscal policy would maintain thecommitments embedded in the social-welfare system, even as demographic andother forces drive up costs (especially for health care). It would alsomaintain current consumptions levels and avoid tax increases, while redressingpublic-investment shortfalls in order to boost growth and expand employmentoptions for today’s middle class and future generations. Finally, futuregenerations would not be asked to bear the entire burden of rebalancing.
Obviously, it isimpossible to reconcile all of these objectives. To be fair, some reforms –including tax, regulatory, and health-care measures – will help to restore balancewithout imposing large additional costs on the public sector. But these are notsufficient to rebalance the economy and restore its growth momentum. Simplyput, one cannot sustain current levels of consumption and entitlements without crowding out public-sectorinvestment, unless one believes that the state’s borrowing power is unlimited,and that the intergenerational burden shift is unimportant.
So choices have to bemade. Gridlock, too, implies a choice – one that ensures that some versionof the status quowill be the outcome. What would that look like?
Here some guess workis required. Entitlement programs would likely be reduced, but not enough tooffset a substantial intergenerational burden transfer. Taxes might risesomewhat in the high-income ranges, with the proceeds going to fundentitlements and redistribution. The desire to avoid substantial tax increases(and to sustain consumption levels) will almost surely be reflected in acontinuing shortfall of public-sector investment, in turn undermining long-termgrowth.
Obama’s proposedbudget recognizes that all objectives and expectations cannot be met, and thatgrowth is partly a distributional issue now and an intergenerational issue (andpotentially one of inclusiveness and social stability) in the longer term. Itis an invitation to the US Congress and the American public to acknowledge andaddress the choices and tradeoffs that are needed to establish a sustainablepattern of economic growth – and to ensure a fair distribution of the burden ofgetting there.
The choices are moreextreme in countries where the imbalances are more severe and markets suffermore policy-induced impedimentsto the private-sector flexibility, mobility, and dynamism that continue tobenefit the US. In Italy and Spain, growth is negative, and youth unemploymentis 35% and 55%, respectively. To be sure, this is a moral issue, but it is alsoan issue of political and social stability.
Every country has itsown version of a socialcontract that defines the rights and responsibilities of citizens, therole of the state, and the idea of inclusiveness. The most successful publicpolicies and fiscal choices are those that are not only guided by the enduringvalues embedded in the social contract, but that are also adapted to changingdemographic, technological, and global circumstances.
That sometime meansmaking hard choices of the type that the US and many other developed countriesare facing now. If we make these choices poorly, growth will suffer and futuredistributional choices will be far more painful.
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