Short-Term
Fixes
Mitt Romney has said that when he is
president he will reduce the jobless rate to six percent. Of course, that is
better than the current rate of 8.3 percent. But what will that mean in terms
of the economy performance going forward? There is a formula (namely, Okun's
Law) that can help us tease out an answer to the relationship between GDP
growth and unemployment rates. Okun's law states that for every one percent
increase in cyclical unemployment (difference between actual and full
employment rates), GDP decreases by some constant (2
percent). Suppose Romney gets the electoral college nod, and the next
day, hypothetically speaking, the unemployment rate falls from 8 percent to 6
percent, a drop of 2 percentage points (same as Obama), that would spur GDP
growth by 2 time 2 percent; again the same as Obama. Thus, it is harder to
make the case why Obama should be replaced.
There exist multiple approaches or
competing views for rescuing the U.S. economy from the 2007-2010 great
recession, but two views have gained currency, in part, from what is happening
in the EU, and from the coming presidential election in the U.S. The first is
the stimulus approach followed by the Obama administration, and the second
non-stimulus (austerity) approach adopted by the challenger. These two
approaches are not mutually exclusive arguments. They both assume that
investment would eventually be the catalyst to growth. Obama believes the
collapse in private sector demand caused the recession the aftermath of which
he is grappling with and that government stimulus in the short term can replace
that lost private demand. The expected response to the stimulus, the demand
generated by government spending (i.e. deficit spending) private sector firms
will produce more, and to do that they would need to hire more workers, thus
reducing the jobless rate. This is core of the Keynesian model that enjoys both
evidentiary credibility and sustainability--it's been around for a long time. The
president implemented some of the model's provisions, albeit, modestly, which
might have worked by preventing the economy from going over the recession cliff.
The problem, if I might dare say, is reluctance to "Stand Your Ground." He
vacillates under pressure from the opposition, the people who have expressed no
desire to compromise with him--House Speaker John Boehner and Senate Minority
Leader Mitch McConnell. They might have got their marching orders from Rush who boasted after the 2010-midterm elections, "winners don't compromise with
losers," and prior to that he said, "I want [Obama] to fail." On the other hand, Gov.
Romney maintains that the looming U.S. government budget deficit (and the
national debt) is the problem (i.e. that caused the 2007-2010 great
recession)--this ignores the ripple effects on the U.S. economy (and indeed the
global economy) of the seismic financial fallout (and the housing market collapse) of
such erstwhile stalwart giants like Lehman Brothers and Woolworths in 2008; Merrill Lynch was gobbled up by Ban of America for a mere $50 billion; AIG, being to big to fail, meant Uncle Sam had to become its majority owner (holding 80 percent of its stock); and Fanny Mae and Freddy Mac are now government owned institutions. This begs the question, what's the solution? Romney's solution: massive cuts in government spending--including police,
teachers, firefighters, plus higher-end income tax cuts--to restore public
confidence in the government: confidence, which some people believe would lead to
renewed private investment and economic growth, without the need to raise taxes in the future. Obama's solution: more government spending and tax cuts to stimulate total demand in the economy.
By and large, it seems stimulus plans are a
nonstarter around the world but mainly in the EU where austerity is the name of
the game. The problem with austerity is it is the wrong pill for the wrong
ailment. Deficit hawks assume that deficits cause recessions. Hence, austerity
is the remedy. I have not aware of evidence for this. On the contrary,
recessions cause deficits--there's lots of evidence and intuition for this. So,
the remedy is transparent, correct the recession and you fix the deficit. For an empirical test of
cuts--austerity--look no further than MP David Cameron's Britain: it has not made
them better. (click here)
The Eurozone demand for austerity (led by German Chancellor Merkel as
conditions for bailouts) has been met with massive demonstrations in Greece and
Spain. These demonstrations are not an argument against austerity, which can
have dramatic effects on people livelihood. They are reactions to an assault on
a way of life. But more broadly, I am yet to discover evidence that austerity
works. Even the French populace reacted to less than draconian austerity
prospects by handing President Sarkozy a pink slip, i.e. he lost his job to the
socialist Francois Hollande, who is not likely to pursue austerity as a policy.
Secular
Issues of Concern to the U.S.
Given the stellar performance of the Chinese
economy in recent years, this hybrid system of communism cum market economy
will overtake the U.S. as the world's leading economy in a generation, if the current rates of growth of the two countries continue
unchanged going forward. More to the point, in terms of sheer size, the U.S. economy is gargantuan. Its annual output
of goods and services is approximately $15 trillion (or $14,582.40 billion) and
its growth rate, 2 percent. But the U.S. average economy growth rate from
1948-2012 is 3.23 percent a year. Restore this 3.23 percent growth rate of GDP,
and we can stave off the Chinese challenge a little longer. The People's
Republic of China by comparison puts out roughly $5,878.63 billion or $5.8
trillion annually (2011). The Chinese economy grew at 8.1 percent (2011), according
to Trending Economics. (click here) With the
caveat that nothing changes, a simple calculus would reveal the exact year when
the two economies will converge.
At first blush, you would think there is no
way China will catch up to the U.S. given it is only a third as large. But
China is growing by a factor of four faster than the U.S. and that makes a
tremendous difference. Here's a familiar high school math example: suppose a
goal post is 12 miles away from the starting line and there are two runners A
and B. Runner A can average 2 miles an hour and runner B, 4 miles. Runner A is
4 miles from the starting line at the start of the race. The race starts at 1
p.m. At 2 p.m. runner A is 6 miles away and runner B is 4 miles away. And at 3
p.m. both runners are 8 miles away the finish line. But at 4 p.m. runner B is
at the finish line, while A is 2 miles behind. This is the kind of race the
U.S. and China are running, with the U.S. ahead by a factor of five in terms of
GDP. With a smidge of math for jiggling the numbers we can come up with a date
when the two countries' GDPs will converge. The answer is 14.89 years! Or, starting from 2011, conversion
will occur in approximately 2026.
Is this good or bad? I think about this
often. Plato said, "Man is the measure of all things." This seems an oblique
way to say we (he probably meant the aristocracy) determine right or wrong, good or
bad. The answer to the question was echoed by the playwright Shakespeare in the
voice of Rosencrantz babbling to Hamlet, "There is nothing either good or bad,
but thinking makes it so . . ." in the play Hamlet. If we drill down to the
world of quantum physics we find that things (electrons) can be different
things at the same time. In terms of the peculiarities of quantum mechanics
where a particle (an electron) can be in two places at the same time, the 'Schrodinger's cat' comes to mind. Economists try sometimes for more certainty than
philosophers, playwrights, and scientists in the world of quantum physics where
probabilities reign. Even economists who are fond of quantitative analysis can
be frustrating admitting that truth might not be absolute.
First the Good!
I have always maintained that if a country
wishes to give away its labor, capital, and technological resources embedded in
its products by dumping them on a foreign (our) market, I would cheerfully
accept their gift, and then I'd dash to my computer and fire off a 123Greetings
card to thank them. Giving away its resources is precisely what China does when
it devalues the Yuan to make its goods cheaper in terms of dollars. Send them
"a thank you note. But some of our politicians complain that China's outstanding
performance can be traced to us trading with them on a tilted surface where
their goods are favored over ours in exchange. And that the cheap (devalued)
Yuan is one enables this. Nevertheless, with devaluation I need fewer American
dollars to buy the same amount of Chinese products. I'm happy.
Since with this scenario, the Chinese sell
more of their goods to us than we sell of ours to them, they are accumulating lots
of U.S. dollars, which they have employed in the purchase of U.S. government
interest bearing securities, i.e. U.S. government bonds by the tune of $1 trillion--$1169.9
billion worth as of March 2012. Well, if I were the U.S.
government, I would be begging the Chinese or anyone else willing and able to
buy my securities to take them. Why? Because the interest (coupon) rates on the
bonds are in the basement. Then add a dash of inflation, and the real interest
payment obligations on U.S. government bonds are very low by historical
standards. One final point, with all the dollars out there in circulation, it
is only a matter of time before inflation rears ugly its head, and the U.S.
government will be paying back it lenders including the Chinese with cheaper
money in terms of purchasing power.
Next the Bad!
Devaluation is like a two-edged sword. When
China devalues the Yuan U.S. goods become more expensive in terms of the
Chinese currency, so we sell less of our goods to China. Two things are
occurring here, American manufactures find it difficult to compete in the
international market, Chinese market, and have to cut back on production at
home, and they are forced to fire some of their workers. Generally, this is not
good for the American economy. The export sector of an economy is likely the
most efficient in utilizing that country's relatively scarce resources. Thus,
the loss of foreign exchange earnings from devaluation means the U.S. can
finance few imports from China. Now, instead of buy Chinese goods, we resort to
producing them ourselves with the help of some trade barriers--import tariffs
for instance. Some people would say, "Good for us!" But not so fast with the
self-congratulatory speeches because this means you (the U.S.) will be
redirecting it resources from the most efficient use (export sector) to the
least efficient use (import replacement sector). On the other hand, the Chinese
economy benefits from this and gets even stronger. Its industries that export
goods the U.S. market benefit from devaluation and can export more. These
industries can now hire more Chinese workers, and thus, continue to grow the
Chinese economy. The Chinese export earnings will give them a greater command
(a larger share of U.S. output) in coming years. This could exacerbate the
trend in the direction of expected Chinese economic dominance.
The Wrap
A decade and a half, 14.89 years, is a
quasi-long time. In fact, I posited initially that in that timeframe the
Chinese economy would overtake the U.S. economy if the current rates of economic
growth carry over into the future. However, anything can change in the interim.
Unforeseen events always lurk in the shadows and can pounce on the unwary with
lightning alacrity: a war--with Iran (Bill Kristol gets to bomb Iran--(click here)--an
Arab Spring reprise, an unanticipated recession, hostilities with North Korea
over their nuclear weapons program. More farfetched events occurring: the Mayan
calendar is true (and December 21, 2012 is the end--apocalypse), or Asteroid
2012 DA14 approaches the earth maybe too close for comfort in 2020; and God
forbid, global warming might be real. These are all potential game changers.
But, alas, I'm being an irresponsible alarmist. I apologize. Yet, anything [everything]
can happen and change the trajectory of history with consequential outcomes for
the balance of economic power.
Fixing the economy should be our number one
priority. Assuming none of the calamities described above happen, then in a
sense, the coming presidential election in November 2012 will be a referendum
on which of the two approaches for mending the U.S. economy is preferable in
terms of economic viability--stimulus (more government spending) versus
austerity (less government spending). Some ongoing political bickering over
which solution is right (versus wrong) is inevitable. Right or wrong (stimulus
or austerity), these prescriptions are essentially short-term fixes. But the
U.S. has long-term structural issues such as the loss of economic hegemony
worldwide due to China's coming of economic age and U.S.'s ethnic
transformation due to a higher minority birth rate propensity. As alluded to
earlier, there is a possibility that China will overtake us in 2026. Add to
that the fear of the browning of America circa 2050. These two events of near simultaneous
occurrence in the grand scheme of things might play such havoc on some people's
psyche that we might need to construct a padded fence
around us to keep from doing ourselves harm--from ethnic tensions and Sino/U.S. commercial
hostilities.
