The depressing state of politics deserves special mention among the problems we face. Having acted in the past to create unfunded, ballooning benefit burdens, politicians – albeit a new crop – now largely refuse to agree on action to reduce them. And no one seems to be penalized for failing to find a solution.
Just as the need for unanimity will frustrate Europe’s attempts to solve its problems, U.S. politicians seem to value things like “ideological purity” (i.e., toeing the party line) and being reelected above real attempts at problem solving. They say they want to solve the deficit problem, but tax increases are off limits for many; cuts in entitlements are anathema for others; there isn’t enough discretionary spending left to cut in order to solve the problem; and “compromise” has become a dirty word.
In 2010 a group of active and retired politicians – the Simpson-Bowles Commission – was asked to come up with a solution. Eleven of the eighteen members supported a responsible proposal including, of course, some pain, but there wasn’t the fourteen-vote supermajority needed to formally endorse it. Congress and the White House let it die of inattention. Despite the enormous danger presented by our current and future deficits, too few were willing to touch matters representing the “third rail” of American politics.
Of course, it’s not just the politicians. Many voters say they prefer elected officials who will refuse to “desert their principles” (that is, compromise with the other side in pursuit of a solution). While some voters may understand the risk presented by entitlement programs, most reject any reduction of their own benefits.
Paul Ryan, the Republican nominee for vice president, is a “fiscal wonk” who cares about the deficit and has a “Ryan Roadmap” to shrink it. Here’s what he says on the subject:
Washington has not been telling you the truth. If we don’t reform spending on government health and retirement programs, we have zero hope of getting our spending – and as a result our debt crisis – under control. (The New York Times, August 12, 2012)
Ryan was chosen for the ticket because his hawkishness on the deficit and overall conservatism were expected to appeal to the Republican “base.” But ironically, Ryan’s interest in reforming entitlements may constitute a disadvantage on the campaign trail, requiring some serious backtracking. Too many people simply vote their wallets: self-interest usually trumps ideology. While we can disagree with Ryan’s approach, we should applaud the rare politician who is willing to tackle this unpopular subject.
Given the way “inflation hawks” on the Federal Reserve Board resist stimulating the economy when a recovery is underway, there’s concern over the ability to count on further stimulus. However, I expect the Fed to keep interest rates low for a prolonged period of time and/or undertake other stimulus actions. Recent statements from Chairman Bernanke leave little doubt on this subject. On the other hand, just as I think a lot of economics is determined by psychology, so do I believe a lot of the impact of stimulus programs is psychological. Interest rate cuts, and bond buying programs like QE, have shock value when first announced, but I think it diminishes over time. In the end, it’s not easy to make an economy grow when people aren’t thinking expansively.
Today’s low interest rates, engineered by the central banks, mean that investors are consigned to doing business in a low-return world. Interest rates near zero on T-bills, and yields of 1-3% on Treasury notes and bonds, set the base from which the prospective returns on investments entailing risk are established. And because that floor is so low today, even with healthy risk premiums added, the absolute prospective return on many investments isn’t nearly what it was in the past.
The long-term competitive position of the U.S. is threatened by our deteriorating infrastructure in areas like education, healthcare and transportation (as well as trends that are enabling other nations to catch up to us in these regards). These are things that made America great following World War II, but there seems to be little will (or money) to restore them to previous levels.
In my view, growing income inequality is a significant problem. The difference in incomes between those at the top and those at the bottom has risen dramatically, and the ability of those at the bottom to move up the chain has declined. Tax rates applied to income on capital (capital gains and dividends) have been cut relative to those on labor. Finally, everyone knows more than ever about how well the people at the top are doing. A lot of America’s economic success has stemmed from the fact that people in the lower income brackets felt the system would allow them to move up through hard work. To the extent that becomes less true – and the outlook today is guarded, especially given the low quality of public education – there can be negative ramifications for society overall.
The world of today seems full of intractable challenges. Think about the list of actual and potential problem areas: Iraq, Afghanistan, Iran, Israel/Palestine, Syria, Pakistan, North Korea, and occasional flare-ups in former Soviet republics. In contrast, the period from the fall of the Berlin Wall (1989) and the USSR (1991) up until the attacks on September 11, 2001 seems like a halcyon one largely free of conflicts considered capable of destabilizing the world. The comparison is stark and troubling.
The last big element of uncertainty on my list is the outlook for China. In the years leading up to today, what characterized China?
- underused resources, largely human, and low manufacturing costs,
- an economy directed centrally, not by free market forces,
- rapidly growing financial resources,
- a strong desire for economic growth and industrialization in order to move the population to the cities and upward in economic terms,
- the need to respond to the global financial crisis of 2008 and the non-performing loans it produced,
- an expectation that manufacturing would expand without limit as China supplied goods to nations around the world as well as its own growing consumer class, and
- resulting certainty that China couldn’t miss.
The upshot of all of the above was massive provision of capital in order to advance China’s economic development and urbanization. State-owned enterprises were created and expanded, and infrastructure building was accelerated. Residential construction, in particular, took place at an elevated rate.
This may have been yet another instance where too much money led to bad capital allocation decisions. China’s modern era had seen only growth, not cycles of boom and bust. Even when the central government wanted to rein in the rate of building, local governments – which derive a lot of their revenue from sales of land for development – were not similarly motivated. Chinese individuals faced very limited options for investing their capital: bank interest was below the rate of inflation and thus negative in real terms, and foreign investment was prohibited. This combination drove large-scale investment into either properties or savings products known as “trusts,” the proceeds of which flowed into fixed asset development. Thus the process went out of control. Good intentions around urbanization and infrastructure development fell victim to massive speculative capital flows. The consequence was excessive fixed investment.
