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Posts Tagged ‘US economy’

If you are looking at political risk in America ten years down the road, what variables would concern you the most? I’d propose a combination of fiscal and poverty uncertainties, and an underlying demographic certainty. This post is about the two uncertainties; I’ll talk about demographics in the next one.

Fiscal uncertainty

The most recent fiscal years recorded the two highest budget deficits in the US since World War II. The Congressional Budget Office (CBO) estimates that on current trends the federal debt will rise from 62% to 87% of GDP by 2020, and all government debt (federal + state + local) will be 110% [1]. This, according to IMF, is among the worst fiscal trends in the advanced industrial countries.

The uncertainty is about what will end up being done to reduce debt. Though America has been able to borrow easily from abroad, that faucet is getting tighter. President Obama’s Simpson-Bowles commission is coming up with proposals, targeting entitlements (social security, Medicare, etc.), which make up 60% of government spending. Retirement age will be increased, Medicare benefits will decrease, along with a host of other initiatives.

The proposal to reduce government debt prioritizes spending cuts over tax increase. Congress just decided to extend Bush-era tax cuts, which adds to the fiscal uncertainty no matter how one looks at it. 70 percent of the debt reduction is to be achieved through spending cuts. But my forecast is that cuts in spending will largely bypasses defense and security, the largest component of discretionary spending [2]. Although the Simpson-Bowles plan calls defense cuts, including closing one-third of overseas bases, Republicans want to prioritize non-defense discretionary spending, which, according to The Economist, “would entail savage cuts to federal services without cutting the deficit much” [3].

Income uncertainty

Now here’s the wider context in which the “savage cuts” are planned. According to the 2010 census results, median American households have become poorer over the last decade. Between 1999 and 2009, national real median household income has fallen from $54,058 to $50,221. It has decreased in every state except five in which income is derived largely from natural resources, such as Alaska and Wyoming. In places like Michigan, median income has fallen by a drastic 21 percent [4].

As of November 2010, unemployment rate was 9.8%, quite high [5]. Many argue that the effects of the stimulus package are wearing off, which was behind the Fed’s decision two weeks ago to inject another $600 billion into the system. But the proportion of the employed population that has taken limits on pay, such as furloughs, pay cuts, etc., is the highest it has ever been. The latest addition is President Obama’s 2-year pay freeze for federal government workers. This freeze, by the way, excludes defense.

In the next ten years, will real household income recover significantly from this trough? That part is uncertain. In New York City, income has bounced back. In Q1, 2010, average weekly wages there have increased almost twelve times the national rate [6]. The main reason is that the government’s bail out nicely got Wall Street out of the mess it had created in the first place. But Main Street languishes.

A scenario grid

If we put these two axes together, as shown below, we have a crude 4-scenario matrix. Obviously, this is ideal-type—but it helps us visualize political risks.

A Rough Scenario Grid, 2020

The X-axis is about the fiscal uncertainty, specifically, the proportion of non-defense-related budget cuts in overall government austerity measures. The higher the proportion (shown on the right hand side), the greater the negative impact on welfare programs. The left quadrants depict the opposite: greater share of defense and security-related spending in overall budget cuts. The balance is uncertain because it will depend on Republican vs Democratic tussles in the coming years. Nonetheless, both welfare and security-related cuts will directly affect a large portion of the population. As economists Sam Bowles and Arjun Jayadev estimate, in post-9/11 America, 1 in 4 Americans in the labor force are direct or indirect parts of the security industry [7].

The Y-axis is about poverty, specifically the extent to which median households are able to recover from their downward trend in income. The bottom quadrants depict continuity of stagnation or an actual decrease in real income. The top quadrants depict a rosier picture, where the economic stimuli have worked, private sector begins to grow and employ more people, the government as a consequence gets greater income, and in general, all is well economically.

The top left quadrant, “Liberal Peace” is a situation in which real incomes have risen again. Because of higher tax receipts and political decisions, the social safety net has remained largely intact. However, cuts in defense have forced America to become somewhat isolationist, especially compared to the interventionist foreign policies of the 1990s and 2000s. In international relations, US has adopted the approach of “Live and Let Live.”

The bottom right quadrant is “Confrontation.” Median income has stagnated, but social services have been scaled back significantly. A greater proportion of people are floating, and desperate. In addition, large spending on defense and security continues, and America is continually embroiled in foreign interventions. The domestic security industry is also booming. In my mind, this is the politically riskiest combination.

So, which one, roughly speaking, are we heading toward? What other big variables might come into play? And what happens if the any of the other quadrants materializes?

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Note: [2] Discretionary spending is spending that is not statutory, i.e., it needs to be proposed and approved every year. The other references are linked directly to the sources online.

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President Obama’s budget projects 1.3 trillion dollars in deficit in fiscal 2011. This has provoked a Republican outrage that I simply fail to understand. Here are the facts:

  • When President Bush came to power, America was in its 3rd consecutive year of budget surplus.
  • He cut taxes and went on a spending binge, with strong Republican support. He eventually spent more than any other president since LBJ, including nearly a trillion on the invasion of Iraq.
  • In the process, the Republicans used up the surplus so swiftly that America ran a large deficit 7 out of the 8 Bush years, consecutively since 2001.
  • They accelerated the hands-off policies started during the Clinton era, giving financiers the biggest say in a democracy, and ushering the biggest downturn since the Great Depression.
  • The administration spent another $868 billion on bailing out the financiers and providing stimuli before bowing out in 2008.

So after the “frat boy shipped out,” as The Economist put it, leaving America in a mess on multiple fronts, his supporters are now upset that the “socialist” Obama administration has to run another budget deficit?

This is the type of irresponsible amnesia on part of the Republicans and the Tea Party fanatics that’s going to hurt America’s global position.

And that’s what my article is about.  But I had to introduce the context, because another irresponsible refrain you hear from the right is that the rest of the world is just out to get America.

My question is, will the world continue to sponsor the debt that the United States has raked up? America’s “aura of invincibility,” wrote David Sanger in the New York Times, will last “maybe a long, long time.” While investors would malign any other economy under similar management, it shrugs off “American financial exceptionalism.” So the capital markets worried this week about Europe’s growing debt, but they hardly paid attention to Moody’s polite warning that America’s financial health “will at some point put pressure on [America’s] triple-A government bond rating.”

This optimism and this belief in exceptionalism is a dangerous consequence of the way US politicians allowed the development of a neo-laissez faire: Just borrow and spend, all will be fine in the end. You see that in consumer habits, in subprime markets, in Wall Street’s philosophy of heavy leverage, and in wanton federal spending while lowering taxes. Risk management was mostly rhetoric.

And so, the US government debt burden now is 85 percent of GDP. This is higher than the proportion in the “socialistic” Europe vilified by the American right. Germany: 79 percent, France: 77 percent, Portugal: 76 percent, Britain: 69 percent, and Ireland, which IMF claimed was the sickest of them all: 61 percent.

Still ok, if someone (read: China) is willing to underwrite the debt. China still holds the world’s highest share of US treasury bonds, almost $800 billion worth. But it has been buying less and less, signaling discomfort.

In the 1990s, Canada lost Moody’s triple A rating when its combined federal and provincial debt approached 100% of GDP. As the US inches to that level, a ratings blow may be nearer than most optimists believe.

And for America, that type of a blow will be more than economic. It will send a powerful political message about the overstretch of the world’s superpower. The world wants to believe that US politicians will be able to enact meaningful fiscal change, keeping its long term financial health squarely in sight. But so far, especially with the naysaying, amnesiac, and reactionary performance shown by the right, they will have little to find comforting.

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The global recession is beginning to end. Asia is beginning to recover: South Korea, Taiwan, and India are doing very well. Some countries outside are also faring better, and we’re beginning to see commonalities as to why. In this post, I’ll point to two examples.

The first is from the Economist, Aug 8-14, on the strength of the German economy:

Germany’s economic machine is made of honest iron and steel, not subprime mortgages, collateralised debt obligations and other financial chicanery. Having been concocted in Wall Street and the City of London, the crisis, it is said, has proved the merit of Germany’s solid social-market economy.

The second insight is about Brazil, which was “one of the last [countries] to enter recession and now looks like being one of the first to leave it.” The ingredients are:

  • responsible economic policies, ignoring pressures from left-wing Workers’ Party.
  • insistence on “rational economics” and free trade, and.
  • “ambitious social policies have helped to lift 13m Brazilians out of poverty; searing inequalities of income are narrowing steadily.”

See any commonality? Social safety nets. Social policies–public support for good health, good education, minimum income, and crisis assistance. In fact, this insight is supported by decades of serious research. (I will write about that in another post.) And it’s not just policy (frequently and stupidly derided in the US as big government), but an economic culture that is thankfully more social-ist.

In America, of course, sustaining social support needs an astonishing amount of selling, so much so that the government finds it easier to bail out big investment banks and big insurance companies, whose criminally-negligent incursions into risky financial products helped create the crash in the first place, than extending funds for a sound healthcare system. Funds for public education, similarly, have been difficult to come by for years.

Yes, in the end big banks got us in the mess, and as Paul Krugman says, big government has saved us. But that’s true if “save” = “getting worse more slowly.” 

If saving = learning so that the next recession may be less of a surprise, then it’s another story. The American style of capitalism–the type that has prioritized home ownership over thrifty spending habits as the mark of success, and typically promotes the likes of Rumsfeld and Paulson as the main shapers of fiscal priorities–is sure to not learn well from this recession. The priorities of the economic culture of Brazil and Germany are quite different.

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As the global recession deepens, the big question is whether we will see a repeat of the protectionist and nationalist policies that marked the Great Depression era.

In the US, President Obama had to temper down Congress’s Buy American provisions to ensure that that the US stance is not misinterpreted. But he is under pressure to consider greater forms of protectionism.

The UK Prime Minister Gordon Brown addressed the US Congress yesterday, and tried to support a pro-globalization position. But he is also under pressure. Anti-immigrant sentiment is rising in Britain. Demonstrations have taken place even against fellow workers from other EU countries.

Both Obama and Brown may be sheltered a little bit, for they don’t face immediate elections.

India is heading for elections next month. While the major parties, Congress and BJP, are pro-openness, fallout from the global slump may begin to empower the Bahujan Samaj Party, which draws more from the poorer classes and the lower castes. If BSP gets a bigger share of the electoral pie (which I think it will), then Indian policy will be under pressure to extend protection of the poor. Deficit spending will rise there as well.

It is unlikely that India will become protectionist. But it will have to diversify, because no matter how rosy its industry associations are sounding, FDI will continue to fall for the foreseeable future.

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