Beyond the Stimulus: Time to Get Real

In remarks on Friday following a meeting with Fed Chairman Ben Bernanke and Sheila Bair, Chair of the Federal Deposit Insurance Corporation, President Obama pointed to some “glimmers of hope” in the economy, and indeed a few green shoots – rising mortgage refinancings and a slight uptick in durable goods orders – have appeared in recent weeks.

But the economy is still in trouble. Don’t bet what remains of your 401K on the White House’s optimistic growth forecasts of the economy rebounding to 3.2 percent to 2010 and then improving to more than 4 percent on average for the next three years. Given the damage the housing and credit bubbles have done to the economy and the inadequacies of the administration’s economic recovery program, these growth assumptions are unrealistic. If anything, we will eventually need another better directed stimulus package before we see the kind of sustained economic growth the White House is predicting for the years beyond 2010.

With its growth forecasts, the President’s economic team is betting on a sustainable V-shaped recovery typical of a normal business-cycle downturn. But as his team knows, this was not a normal business-cycle recession. For one thing, consumer spending is unlikely to return to its bubble-year levels given high household debt levels, slumping home prices, and constraints on credit expansion. In addition, unemployment is not expected to peak well in double digits until later in 2010, and thus it will put downward pressure on wages and incomes for some time to come. There are also serious impediments to increased business investment, not least of which is the fact that businesses have little incentive to invest given weak demand and excess capacity in many sectors.

To be sure, Obama’s economic recovery program will help soften the economy’s fall as households and the financial system deleverage and rebuild their balance sheets. But it fails tragically to put the economy on a new more sustainable growth path. First, the $787 economic recovery program passed by Congress in February is too unfocused, too scattered over many areas, and too concerned with social spending to create a big new source of economic growth given likely lower levels of consumption in the future.
The administration’s much-hyped green investment agenda comes to about $17 billion a year, far short of what is needed to create a new driver of investment and job creation.

Indeed, on balance, the White House’s green energy agenda could actually become a drag on any economic recovery. The administration’s proposals for doubling the contribution of renewable energy by 2012 will make at best a modest contribution to energy supply. (Together, wind and solar sources produce only 1.1 percent of America’s electricity consumption and a far smaller percentage of all energy use.)

Meanwhile, the cut-back in the domestic exploration of oil and gas, caused by falling prices and by Obama’s withdrawal of incentives for exploration, seems likely to reduce the domestic supply of energy by as much or even more. This a prescription for a new spike in energy prices that could snuff out any recovery just as it gets going. In the short term the administration’s green investment agenda may actually cost the economy jobs in the energy sector and lead to higher imports of foreign oil.

Second, the economic recovery program is too concerned with short-term consumption as opposed to long-term investments in our public infrastructure that can create jobs and improve U.S. productivity. The White House estimates that the economic recovery program will create or save at most 3.5 million jobs over two years. Private forecasters are less optimistic and put the number at less than three million. But given the scale of job losses (now running at more than 600,000 per month) created by this recession, the economy will need to create 9 million more jobs to return the economy to something approaching full employment. Wages therefore are not likely to show any significant improvement any time soon, thereby eliminating the possibility of wage and income-led growth in the short-term. At the same time, weak private and public investment will undercut future gains in productivity, eroding the foundation for long-term income gains.

Third, a sustainable economic recovery depends upon a strengthened tradable goods sector and a sustainable improvement in our trade balance. In order to work our way out of the debt accumulated during this crisis and, at the same time, improve American living standards, we will need to export more and import less. But the Obama economic recovery program will at best provide only a modest boost to America’s manufacturing sector. The most important help will come from the increased infrastructure spending included in the economic recovery program and the 2010 budget. Good basic infrastructure is critical to the success of American-based manufacturing companies, and the program will create some improvements in this area and relieve some bottlenecks that are now preventing increased investment.

There are, however, other aspects of the Obama program that are much less favorable to the strengthening of manufacturing. As suggested earlier, the Obama green energy strategy will raise the cost of energy to American producers, and thus create new disincentives to business investment. In recent days, the White House has backed away from the president’s ambitious proposals for cap-and-trade, but some Congressional members of the President’s party are determined to push forward with this misguided policy.

An improved trade balance also depends upon stronger global demand, critical if the exports are to increase in the months ahead. The president understands the importance of rebalancing the global economy with the large current account surplus economies consuming more and saving less. But even though the president received high marks for his recent European trip, he gave up more than he received in this area. Large current-account economies like China and Germany need to increase their fiscal stimulus to encourage more consumption. But in face of resistance from Germany and France, the administration quietly dropped its call for G-20 countries to commit to a modest 2 percent of GDP target for fiscal expansion. At the same time, the administration pledged to resist Buy America provisions and other measures that would ensure that the US stimulus does not leak out of the economy and help economies free-riding off world demand. As a result, once again the U.S. economy will bear a disproportionate burden in pulling the world economy out of a deep recession.

The basic point here: The administration’s program is not properly structured to create a bridge to a new healthy pattern of economic growth. It is too reliant on the Federal Reserve and its program of quantative easing. At best, this will create a pale version of the debt-financed consumption-led economic growth that we experienced over the last five years – with a new bubble forming in commodities and energy that will act as a drag on a sustained economic recovery. The economy may experience a short recovery that will peter out into a prolonged slow-growth recession with high unemployment as stimulus dries up and energy prices begin to rise

So how do we avoid this prospect? We need a second economic recovery program, one that focuses on the economic basics of encouraging real investment and demand creation. This economic recovery program would be more strategically focused on creating jobs with more emphasis on investment in America’s tradable goods sector. It would include the following features:

This economic recovery plan should be accompanied by a new global diplomatic initiative that would push for new rules of trade and investment that would force chronic current account surplus economies to expand domestic demand and increase support for international development. If successful, such a global rebalancing plan would increase demand for U.S. good and services. This together with the domestic measures above would enable us to reduce America’s trade deficit and to stimulate private investment and job creation in our tradable goods sector.

This program would represent a real sustainable economic stimulus for the country because it would create a new pattern of economic growth – one that no longer relies on debt-financed consumption but focuses instead on raising real wages and incomes through investment and job creation in America’s productive economy.

Sherle Schwenninger directs the New America Foundation's Economic Growth Program and the Global Middle Class Initiative. He is also the former director of the Bernard L. Schwartz Fellows Program.