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Governing the U.S. Economy in a Globalized World
Fauver and Associates, former G7/G8 sherpa
Text prepared for presentation at the Munk School of Global Affairs, November 15, 2013
It is a pleasure to be back in Toronto.
As you are aware, Washington has been a very strange place in recent months. Leaders of the two political parties essentially not speaking with each other. Congressional republican members are ignoring their party leaders instructions. And filibustering for 21 hours. That is a long time to talk. Not even professors can match that.
The Congress threatens to default on US debt. The President says in essence 'make my day'!
In a country that gave us Google, Amazon, Facebook we have a government that cant design a simple website in three years and after spending something on the order of $600 million dollars.
So it is a nice change of pace to be in a city run so efficiently. And so quietly. No leadership problems. No political gaffs. Sane leadership.
When I first started working with John Kirton and his group the annual gathering of Heads of State and Government was comprised of 7 Industrial nations. What a change we have seen over the last 20 years or so. Now we have the G20 which as you all know isn't really a group of twenty, but after including the international institutions — IMF, World Bank, and others — is more like a group of 24. But from time to time even that number understates the size of the body as special guests are invited to participate in the discussions in most years.
So John has taken the world of summitry from a manageable 7 to a currently unmanageable 24 plus. Well done John!
I want to talk today about the US economy, the challenge of coordinating with others in the world economy, and future pitfalls.
The outlook for the United States economy continues to be rather mixed. Since the 2008-2009 major economic recession in the US economy has never experienced a real growth rate above its potential long term growth rate. This is an unprecedented recovery period in post-World War II history. So far during this unusually weak recovery, the strongest real growth rate has been 2.8 percent recorded in 2010. Since that first year of the recovery process, the real growth rate has been essentially flat at 2 percent in 2011 and 2012. It is again forecast to be roughly 2 percent this year. Largely as a result of this weak recovery performance has been the very weak job creation experience. Unemployment rates have been very slow to trend downward. The unemployment rate peaked at roughly 10 percent in October, 2009 at the height of the recession. As of September, 2013 it had been reduced to 7.2 percent. Last Friday, the Department of Labor announced that rate had risen a bit to 7.3 percent in October.
Many commentators have focused on problems with US employment and unemployment data. In particular, they observe that measurements of unemployment discussed by the Administration and in the popular press significantly understate the actual rate of unemployment. For example, during the recent recovery period substantial numbers of individuals have simply dropped out of the work force. They have in essence given up on finding work.
The U.S. labor force keeps shrinking rapidly. Back in 2007, 66 percent of Americans had a job or were actively seeking work.
On Friday November 8,, the Labor Department reported that 720,000 Americans left the labor force. This exodus pushed the labor force participation rate down to 62.8%, the lowest level since 1978. One out of three adults in neither working nor actively looking for work.
So why is the labor force dropping? There are a couple big factors going on here. Older Americans are retiring, younger Americans are going back to school, and many workers have been discouraged by the weak U.S. economy and lack of job openings.
So what's going on? One theory is that the weak job market is causing people to simply give up looking for work — they're crumpling up their resumes and going home. A recent paper from the Boston Fed suggested that these "non-inevitable dropouts" might even account for the bulk of the decline.
The end result of these changes in the labor force suggest that the unemployment rate will be very hard to reduce in the next year or so, even if the underlying economy recovers strongly. The reason for this is that as the economy begins to show domestic strength and hiring rates increase, those workers who have dropped out of the labor force will come back in. The growing workforce will increase the denominator of the unemployment equation hence the unemployment rate will remain high or even increase in coming months.
Most analysts continue to believe that monetary policy will remain easy at least well into 2014. The massive bond purchases under QE 1, 2, and 3 have injected immense amounts of liquidity into the domestic economy. Although the effect of this easy policy has had little positive effect on domestic demand, it has clearly supported a major expansion of equity prices in domestic markets.
The Federal Reserve has stated that the U.S. economy still needs support from the Fed's low interest-rate policies because it is growing only moderately. In a statement released in late October following a two-day policy meeting, the Fed stated that it will keep buying $85 billion a month in bonds to keep long-term interest rates low and encourage more borrowing and spending.
Furthermore, the Federal Reserve statement added that it plans to hold its key short-term rate at a record low near zero at least as long as the unemployment rate stays above 6.5 percent and the inflation outlook remains mild.
The Fed again noted that budget policies in Washington have restrained growth, but it made no mention of the 16-day government shutdown. However, the Fed no longer expressed concerns about higher mortgage rates, a concern it flagged in September.
Since the September meeting, mortgage rates have fallen roughly half a percentage point and remain near historically low levels. Over the summer, rates had jumped to two-year highs on speculation that the Fed might reduce the pace of its bond purchases before the end of this year. Few think the Fed will reduce its stimulus any time soon. Many analysts now predict the Fed will maintain the pace of its bond purchases into next year.
The January 2014 meeting of the Federal Open Market Committee will be the last for Chairman Ben Bernanke, who is stepping down after eight years. President Barack Obama has chosen Vice Chair Janet Yellen to succeed Bernanke. Assuming that Yellen is confirmed by the Senate, her first meeting as chairman will be in March. Many economists think no major policy changes will occur before a new chairman takes over.
Janet Yellen is an academic economist with a distinguished record of previous jobs and academic positions. She has taught at Harvard and at the University of California (Berkeley). She served as the Chairman of the Council of Economic Advisors under President Clinton. She is currently the Vice-Chairman of the Federal Reserve Board of Governors.
In terms of economic philosophy, Yellen is essential a liberal economist. Yellen is considered by many on in financial circles to be a "dove" (more concerned with unemployment than with inflation) and as such to be less likely to advocate Federal Reserve interest rate hikes, than other economists. However, some predict Yellen could act more as a hawk if economic circumstances dictate.
Yellen is a Keynesian economist and believes in the modern version of the Phillips curve, which, in its original, pre-1970s form, stated a simple inverse relationship between unemployment and inflation. In her 2010 nomination hearing for Vice Chair of the Federal Reserve Board of Governors, Yellen said, "The modern version of the Phillips curve model — relating movements in inflation to the degree of slack in the economy — has solid theoretical and empirical support." It is worth recalling that during the Carter Presidency, administration economists supported the concept of a Phillips Curve and the economy suffered from very high inflation rates.
The 2013 United States debt-ceiling crisis is part of an ongoing political debate in the United States Congress about the level of the national debt. The 2013 crisis began in January 2013 and ended on October 17 with the passing of the Continuing Appropriations Act 2014, though the debate between republicans and democrats in the Congress continues.
On October 16, 2013, the Congress passed a continuing resolution to fund the government until January 15, 2014, and suspending the debt ceiling until February 7, 2014, thus ending both the United States federal government shutdown of 2013 and the United States debt-ceiling crisis of 2013.
The continuing resolution established a House-Senate budget conference to negotiate a long-term spending agreement, and strengthened income verification for subsidies under the Obama Care. The Senate vote was 81-18 in favor, with 1 member absent due to illness. The House passed the bill un-amended later that day, by a vote of 285-144, with 3 members absent due to illness. The President signed the bill early the next morning on October 17. Under the resolution, the debt ceiling debate and partial government shutdown were postponed, with federal workers returning to work on October 17.
As a result of this agreement, the next deadline for the debt ceiling extension is February 7, 2014. It is highly unlikely that the Congress will successfully negotiate a significant budget agreement before the January 15th deadline. Republicans, especially in the House of Representatives, want to reduce government spending levels and reform entitlement programs such as Social Security and Medicare which are significantly underfunded currently and will require either reductions in spending or increases in revenues over the next 5-10 years. Democrats are demanding increases in federal tax revenues in order to increase domestic spending. After agreeing to a major tax increase for the wealthy last year republicans are likely to be unyielding in their opposition to further tax increases. As a result, Congress is likely to agree to another continuing resolution which extends current spending levels for the year 2014.
Without a significant budget agreement, the Congress is likely to have another heated difficult debate on the debt ceiling. It is unlikely however that the government will go into default on its debt.
Most economists expect a pick-up in the real growth rate during 2014. The consensus forecast is for growth of 2.8% — up from the below 2% forecast for 2013. The IMF forecasts something on the order of 2.7%. It is worth noting that during this recovery, forecasts for the coming year have consistently exceeded reality. For several year, consensus forecasts have been for the next year's growth to come in near potential rates of growth — about 3%. But for three straight years, reality has not met expectations.
The Administration faces a difficult relationship with the US Congress. With very critical mid-term elections coming in November 2014, the next 12 months will present difficult choices for policymakers. The democrats will want to show that republicans are blocking important legislation — immigration reforms, environmental policy changes. And the republicans will focus on the growing size of government, highlighting the problems emerging regarding Obama Care. Not only the web-site failures, but the rise in premium costs for many, the significant increases in deductibles for new policies, and the shortage of doctors foreseen in the future.
Not much will be accomplished in the remaining time before the elections next fall. Typically, congress goes on a long summer recess during election years and barely returns in the fall before another recess leading up to the election.
President Obama is likely to resort to executive orders in order to pursue his policy goals. On the health care front, he will try to use administrative power to fix the existing problems. Today he announced shifting power to state regulators to try to compensate for cancelled policies. He will not turn to the Congress for fixing the problems as he does not want to open the whole piece of legislation.
In the area of environmental issues, he will likely turn to the EPA to craft new regulations and standards. The most far-reaching piece of Obama's climate plan is carbon emission standards for the nation's fleet of existing power plants, by far the largest single source of industrial carbon emissions. The EPA is also writing standards for new plants.
One of the original goals of economic summitry was the hope for better macroeconomic policy cooperation and coordination among the major industrial nations. During the second half of the seventies and the eighties, coordination was fairly successful among major nations. During those times, we never saw a global recession in which all of the major industrial countries were simultaneously in trouble. There was always an odd man out. And this helped stabilize the global economy.
Since the turn of the century, economic coordination and cooperation has fallen by the wayside. Countries are less likely to share policy thoughts among their peers than they used to be. And obtaining political support for the needed policy enactments has proven extremely difficult in the major economies — especially in the US.
International economic policy coordination was easier to achieve when policy makers believed that their only economic issues centered on macro themes — fiscal policy, monetary policy, and exchange rate policy. While coordination has never been perfect, it has helped to smooth the bumps in the world economy — and importantly has helped provide the cover policy makers need to restrain the implementation of beggar thy neighbor policies. Which in hard times are easy to give in to.
But today, many of the economic problems center on structural issues — and not simple macro issues. And these are much more difficult to coordinate across countries. During the 1980's the OECD led discussions on structural reform issues and worked hard to include structural policies in ministerial communiques. Unfortunately many of the structural issues — especially labor market reforms — are simply too political to discuss openly or internationally.
What structural issues are facing the major economies today?
In all major economics, demographics are rapidly changing. The major industrial countries face aging populations. Japan is leading us in terms of the aging process, but we are all following. Many countries are experiencing a decline in the size of the work force. This means that there are fewer and fewer workers contributing to pension systems while the demands of pension withdrawals are rising. Underfunded national pensions systems are plaguing all major countries.
Underfunded pension systems in turn are driving national fiscal deficits to higher and higher levels and national debt levels are rising as well.
In addition to pension problems, aging populations are placing new burdens on health care systems. Both of these entitlement programs are under increasing strains and are drains on the national economies. In all major economies, fiscal problems are confronting policymakers.
From a global perspective, if all major governments simultaneously attempt to reduce government deficits and national debt levels, global demand will suffer and the problem will worsen.
Another structural issue surrounds labor markets. In an increasingly globalized economy, flexibility of labor markets is critical to maintaining competitiveness. Labor markets in the industrial world are not very flexible. In particular, changing technologies require different training and job skills than exist in many work forces. None of the major economies have developed a successful model for retraining labor. And none have major significant adjustments in the educational systems to recognize the new skill requirements.
One hopeful policy area for coordination centers in the international trade arena. The Obama Administration is working hard to complete the Trans-Pacific Partnership during the coming year.
From a broader perspective the TPP talks will be the widest ranging multilateral trade talks in history. From an analytical perspective it is useful to review that status of the TPP discussions. Trade Ministers have identified five defining features that will make TPP a landmark, 21st-century trade agreement, setting a new standard for global trade and incorporating next-generation issues that will boost the competitiveness of TPP countries in the global economy.
New trade challenges: to promote trade and investment in innovative products and services, including related to the digital economy and green technologies, and to ensure a competitive business environment across the TPP region.
Living agreement: to enable the updating of the agreement as appropriate to address trade issues that emerge in the future as well as new issues that arise with the expansion of the agreement to include new countries.
So all is not over for international coordination and cooperation — at least not yet.
The G20 was very useful in 2009 when President Bush called the first leaders meeting to Washington. It was a crisis atmosphere with join worries and concerns. All participants saw that it was in their interest to work together. They provided political support for changes in regulations and rules in the financial markets — capitalization requirements, derivative instruments, and insurance regulations.
Maybe we will need another crisis to rebuild the G20. Perhaps working of structural issues could provide the rationale.
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