September 1, 2012

The Annual Economists Roundtable: How We Get Out of This

Housing, jobs, energy, taxes, manufacturing strengths, the EU and political realities

POLITICS CAN ALWAYS BE BLAMED for for an economy on hold. Certainly they're the target now, as economic indicators over the past few months have barely budged in either direction. It's true, not much will happen until the election is decided on Nov. 6. Yet while the parties bicker over the details this fall, there's one thing we can all agree on: The U.S. economy is a bit stuck in the mud, and needs help.

For the third year in a row, Margo Thorning, chief economist at the American Council for Capital Formation, gathered expert economists for Forward's economic policy roundtable and asked them to talk about the future of the U.S. economy and some of the most critical issues affecting it. Significantly, from the Eurozone and tax reform to exports and alternative energy, these economists are more optimistic than you might think.

Margo Thorning: Let's start out by looking at the U.S. economy. What do you see happening over the next year into 2013?

Gary Hufbauer: Two indexes I look at are the Institute for Supply Management, both for manufacturing and for services. Both of those are about at the 50% level: If it drops below that, we're into recession. They're right at the threshold. Yet I am a little more positive. I don't think we're going to go into a recession. And my reasoning is first that the fiscal cliff will be resolved politically. And second, that the monetary authorities will keep their foot on the accelerator for the foreseeable future. I'm inclined to be moderately more optimistic than the current consensus.

Margo Thorning: How about you Jared?

Jared Bernstein: My view is that the economy is in a bit of a slog and is likely to stay there. By that I don't mean recession. If we get the fiscal cliff all wrong that changes, but I hope and pray we don't. That said, headwinds from Europe and China remain persistent. And most importantly, the job market has never really escaped the pull of the Great Recession. We're adding employment, particularly in the private sector—in fact, solely in the private sector. We've been shedding jobs in the public sector. But demonstrably not fast enough to knock down the unemployment rate.

Along with those headwinds, let me mention two tailwinds, because I don't think things are totally gloomy. First of all, the price of energy has come down considerably. And that's probably adding at least a quarter point to GDP growth, if it persists. But the other thing that's really important is it really does finally look like maybe, cross your fingers, the housing market has carved out a bottom. We've even seen home prices bump up a little bit recently. Now, we've been here before. But I think the indicators are lined up in such a way that you can say with moderate confidence that the housing market has carved out a bottom. Now that doesn't mean you're growing, it just means you're not shrinking. So I don't want to be overly bullish. But if that's true, that's also a tailwind.

John Taylor: I think the economy now is extraordinarily disappointing. We actually have a smaller fraction of the working age population working now than at the bottom of the recession. So we're actually not providing enough jobs to even employ the working force as it is. And it's just tragic for so many people. Unfortunately, as you see some stabilization in housing, you're seeing some worse things on trade. Trade has basically been a pretty good positive. But now exports are weakening. That's a downside. And weaker exports of course not only due to Europe, but also the slowdown in other countries. So we're in a tough situation. We can change things. But we really need 4% or 5% in real GDP growth to get unemployment back down.

And then the last thing is this general uncertainty. Where are we going? This fiscal cliff was created by the government. It's not like it came from outer space and was imposed on us. Policymakers created the cliff.

A Generation of Jobless?

Margo Thorning: We have a lot of people who are unemployed and we're perhaps developing a generation of unemployed people. How serious is this for our future? What can we do about remedying this situation?

The Roundtable

JARED BERNSTEIN has been a senior fellow at the Center on Budget and Policy Priorities since late 2011. Previously, he was the chief economist and economic adviser to Vice President Joe Biden, executive director of the White House Task Force on the Middle Class and a member of President Obama's economic team. He received his Ph.D. in Social Welfare from Columbia University. His expertise includes federal and state economic and fiscal policies, income inequality and mobility, trends in employment and earnings, international comparisons, and analysis of financial and housing markets.

GARY HUFBAUER is the Reginald Jones Senior Fellow at the Peterson Institute for International Economics. He was the Marvus Wallenberg Professor of International Finance Diplomacy at Georgetown University from 1985 to 1992, and holds an A.B. from Harvard College, a Ph.D. in Economics from King's College at Cambridge University and a J.D. from Georgetown University Law. He has written extensively on international trade, investment and tax issues.

JOHN TAYLOR is the Mary and Robert Raymond Professor of Economics at Stanford University. He is also the George P. Shultz Senior Fellow in Economics at the Hoover Institution. In 2010, Taylor was awarded the Bradley Prize from the Bradley Foundation, and the Adam Smith Award from the National Association for Business Economics, for his public service and work as a researcher and teacher. Taylor received a B.A. in Economics summa cum laude from Princeton University and a Ph.D. in Economics from Stanford University. His areas of expertise are macroeconomics, monetary and international economics, and he is well-known for his work of modern monetary theory and policy.

MARGO THORNING, our moderator, is senior vice president and chief economist of the American Council for Capital Formation. She is an internationally recognized expert on tax, environmental and competitiveness issues. She is frequently quoted in such publications as the Financial TimesThe Wall Street Journal and the New York Times. She testifies frequently as an expert witness on tax, energy and environmental issues before U.S. House and Senate committees. She received a Ph.D. in Economics from the University of Georgia and previously served at the U.S. Department of Energy, U.S. Department of Commerce and the Federal Trade Commission.

Jared Bernstein: Economists essentially argue about whether unemployment is a structural or a cyclical problem, meaning that once demand picks up, we can expect to get down to lower rates. Or do we have a problem with the depreciation of the skills of the unemployed such that they won't be able to meet employer demands when the economy picks up again? I've always been in the cyclical, versus structural, camp. But it's a moving target because, as time goes on, cyclical morphs into structural.

I would argue we haven't seen the kind of structural shifting in skill demand among employers that would lead us to be as worried as the question implies. There's about 5 million people who have been unemployed for at least six months. But this dynamic of folks' skills depreciating so far that they're difficult to employ takes longer than that. The more important thing is we bring back demand as soon as possible, and I think we can get unemployment down to historical levels.

Gary Hufbauer: A tremendous amount of the unemployment is concentrated among construction workers because of the collapse of the housing market, and also a pretty severe drop in building commercial real estate. Housing may pick up, but I don't see housing returning to the levels that it had been in the golden periods.

So where are these people going to go? I think what is needed for this very substantial part of the unemployed is a big boost in infrastructure spending in this country. That's the skill set that many of these people have. I am an enthusiast for long-term training programs that are very oriented toward the job market. But I don't think that's an answer for the current generation of unemployed people. It is infrastructure, infrastructure, infrastructure. If we get that, then I would be relatively sanguine about the outlook. If we don't get that, then I would agree with Jared: These people will morph into structurally unemployed because they will lose the habit of actually working, and they will lose the skills they previously had.

But there is one very useful development that is happening across the U.S. economy, and that is the expansion of technical-vocational schools, including community colleges, which are segueing toward the role of technical-vocational schools. These schools and colleges are getting more closely connected to firms, both manufacturing and service firms—they are orienting their programs much more closely to the needs of firms. And that means putting manufacturing executives on the boards. There's an initiative in the U.S. Department of Commerce along this line, so the skill set for the manufacturing industry in this country is improving, pretty substantially. This is very much a state and local effort, with some federal push to it.

Margo Thorning: The other hole in the economy is the younger generation of kids, even college graduates who can't find work. They haven't been working long enough to develop any skills. And it seems to me they represent a generation that is going to have a hard time finding work.

Jared Bernstein: It is tough for kids coming out of college with newly minted degrees, taking a longer time to find jobs, that's been a real problem. But research has shown that it affects their whole career intertrajectory in terms of their income growth. If you happen to start out your career in a downturn like this, it takes you much of your career, if not all of it, to catch up. So it's a difficult problem. And again, this is something where cyclical could morph into structural.

Gary Hufbauer: Well, I'm more optimistic about the college graduates than about the middle-age construction workers because I do think that general growth should pick these people up fairly quickly.

But I do think we could get up 3% or 4% in GDP growth and still not do a lot for the lower-skilled, unemployed workers.

Slowing Exports as the World Slows

Margo Thorning: Exports have been a pretty good source of economic activity for the last year or two in the United States, especially in commodities. What is the outlook for relying on exports as a foundation for economic recovery?

Gary Hufbauer: I'm pessimistic for a couple of reasons. One, world growth is slowing down. Even Latin America, which is one of our great export markets, is dragging along with not nearly the good growth

it once had. And, of course, China is coming down to 7% or 8% growth. And world economic growth is the strongest single factor behind U.S. exports. The second thing is the plight of Europe. I see Europe as stumbling through. But part of this stumbling will be a drop in the Euro to $1 or $1.05. In other words, the Euro will be more competitive against the dollar. And there's a huge overlap between U.S. and European exports. So I see that factor cutting into U.S. market share globally across a wide range of capital goods, and some consumer goods.

John Taylor: We're moving to a stage in this recovery where exports will be providing less of a boost. We had actually very good growth from Latin America and Asia in the first couple years of the recovery. But that's changing. We're actually very close to negative growth now. In the second quarter, we could be at 1% or 1.25%. So any extra surprise from abroad, Europe included, could take us to a negative territory. Unfortunately, we're in a more precarious situation because of that.

Jared Bernstein: I think it's somewhat of a mistake to focus exclusively on exports. I focus on net exports. That matters a lot for our manufacturers, too. And I agree with much of what's been said on the export outlook. But you also have to consider the import side of the equation. And to the extent that a lot of the slowing John has mentioned does occur, we would then potentially be sucking in fewer imports. And so the balance of trade may not be quite as negative as some of the comments made so far would suggest.

Margo Thorning: So what do we think about the Eurozone remaining a viable trading partner?

Jared Bernstein: I have quipped that European policymakers exist to make our policymakers look good.

Gary Hufbauer: My view is that Greece will depart from the Eurozone at some point. But the European Central Bank, through various and sometimes devious means, will keep the rest of the Eurozone together for the next few years while more fundamental reforms take place—if all goes well.

John Taylor: I think until they deal with the inability of governments to deal with their debt and the way that fits back to the banking system, we're going to be in this uncertain area for quite a while. I don't see that resolving itself. I think the problem has not been so much the Euro, but rather terrible fiscal policy, and to some extent monetary policy.

Jared Bernstein: I thought Gary said something very interesting and important when he said something about secretly or deviously moving to try to fix all this. I recall a conversation with some high-ranking German economic officials, who said essentially, I'm paraphrasing, “We know what we have to do. We can't let anybody see us doing it.” You know, that struck me as a plausible stance 50 years ago, but awfully hard to pull off now. I mean, remember how unpopular [the Troubled Asset Relief Program] was here? Imagine if TARP was targeted to bailing out Mexico and you get a feel for how politically difficult the moves are that the core countries have to make in order to achieve some sort of sustainability in the short run.

Taxes and Manufacturing

Margo Thorning: I'm wondering what changes you see on the horizon for the manufacturing sector. What new directions should we be going in or are we going in that will be helpful to make that a more vibrant sector of the economy?

Jared Bernstein: This is a question that is hugely contingent on the outcome of this little old election you may have heard about that's coming up. I think the president has talked quite forthrightly and forcefully about manufacturing policies. And certainly, he has talked about tax and investment policies, mostly clean energy, that I believe would help our manufacturers. He has talked about trying to close an international tax—I would call them loopholes, my colleagues might disagree—that makes it a lot cheaper for our manufacturers to produce abroad. And he's come out for an idea on international taxation of multinationals, which is not the policy that candidate Romney would espouse. So I think there are pretty big differences in that regard. The American manufacturing sector would see more changes on the horizon that would help them at least along some pretty significant margins under President Obama than under Mitt Romney, in the sense that I've said so far.

Gary Hufbauer: President Obama's tax policies are pointing in the wrong direction for the manufacturing sector and for the economy as a whole in two respects. First, we've got an economy where the corporate tax rate is the highest in the civilized world. But that rate only applies to about half the business activity because the other half of activity is conducted through LLPs, LLCs, Sub-Chapter S and other pass through entities, which are vulnerable to being taxed at even higher personal income levels. The half that gets taxed at very high corporate rates is the competitive part of the U.S. presence in the world economy, so the high rates are most unfortunate.

The other point is on the so-called territorial tax—that is the proposal from candidate Romney and others that corporations be allowed to escape taxes on their overseas profits, and that's probably where we disagree most. I think the evidence shows very strongly that overseas investment by U.S. firms is very good for manufacturing activity in the United States in all sorts of ways, including the support of research and development that mostly happens here. This outsourcing baloney, now embraced by politicians of both parties, who talk as if outsourcing is un-American, leads to the notion that Jared has emphasized: We ought to tax our firms on their earnings abroad much more heavily than under present law. This would be a long-term disaster that would curtail the U.S. presence in the world economy in a big way, over a period of 10 or 15 years. So, yes, there are things we can do in the tax world, but I think that Gov. Romney and President Obama have very different visions on that.

Jared Bernstein: I just want to add, I think the international system of taxation is far more screwed up than this conversation would have you believe, and it's hurting our manufacturers particularly in some of our smaller businesses' ability to export as well as our ability to produce more domestically. Because our multinationals can defer tax payments indefinitely, and because they can engage in something called “transfer pricing,” where they can send their profits all around the world in order to avoid taxation, we have the worst of both worlds. I'm not saying that we want to have an uncompetitive tax rate. And in fact, on the books, as Gary said, we do have an uncompetitive rate. But in real life, we don't. In fact, what we have is a pretty big mess that works pretty well for a manufacturer like General Electric Co., which has about 1,000 tax lawyers working to figure out how to do this. That's not productive activity in my mind.

Regulation, Energy and Growth

John Taylor: I think the increased amount of regulations is particularly burdensome to manufacturing because of the more complex products they're producing. And there has been a huge increase in regulation in the last few years. Obviously, that's a cost. You might say the benefits are there, but in the meantime it's a significant cost of manufacturing. Economists always argue for cost-benefit analysis. But I think it's basically being overwritten by political interest at this point.

Gary Hufbauer: U.S. energy prices are declining faster than in Europe and Japan—maybe not faster than in Canada—but faster than in other major competitors, China and Brazil, because of the natural gas phenomenon. And this is a big boon to manufacturing in the United States. That's a long-term plus, which is a windfall that comes out of our ingenious technology, and it's very much welcome.

Margo Thorning: What areas of manufacturing can we expect to see grow over the next five to 10 years?

Gary Hufbauer: The big positives will be in the high-tech areas where we are truly and very competitive. So nanotechnology, biotech, the synthetic materials, all these wonderful materials which are coming out of the labs, plus the whole capital goods sector where we are really foremost. And I thought a very welcome recent sign was Airbus eciding to locate in Alabama, which speaks to the skills of the work force and speaks to the supply network they can draw on within the United States for very large civil aircraft, which are tremendously complicated.

Jared Bernstein: I believe 2011 was the first year in 60 years that we were a net exporter of petroleum products. Obviously, I'm not talking about barrels of oil, I'm talking about refined products: jet fuel, gasoline, things like that. On the other hand, there is potential in some clean-energy manufacturing, particularly in advanced battery technology. Maybe the building of things related to that, like a smart energy, the components of a smart energy grid. There is a policy by the way that's helped in that regard. It's a clean energy manufacturing tax credit that has proven to be pretty useful.

Margo Thorning: Given that our natural gas development could be a huge boost for the economy, should we also allow the exportation of natural gas? What about allowing some of these ports that were built to import natural gas to switch around and export? How will that affect manufacturing?

Gary Hufbauer: Well, I can see the argument for restricting exports of natural gas and other petroleum fuels as an advantage for the U.S. economy. And I should add that the legislation in place already enables the federal government to do just that, plus the states with their regulatory capacity over health and safety of ports and so forth; they can do a lot to interfere with exports. But it would be a huge mistake to regulate the export of energy supplies. It will make our allies in Asia, particularly Japan, quite nervous if we do that. Beyond that, it will take away, as John and Jared said, a possible big, booming export market for the United States. Endowments of natural gas and associated oil are so large in this country that we face a practically flat supply curve for these products. In other words, we're not going to drive up the price here by allowing exports. So I'm really hopeful that our leaders take the high road and do not impose restrictions on these exports in the years ahead.

John Taylor: Well, I certainly agree with that. The potential impact of natural gas on energy production in the United States is a major game-changer. It affects our trade deficit potentially by a significant amount. It affects our ability to contribute to the international energy debate. It's a huge opportunity for the United States to regain some leadership in this area. So I would say this is the general principle: Don't get in the way of that by excess regulations. Just let this amazing technology go and produce benefits for us.

Jared Bernstein: I would agree. Any government, any country that tries to buck the reality that energy markets are global markets will quickly be disciplined in ways they won't like. But it does strike me that we ought to learn more about any environmental risks from fracking. I think we also all agree that we need to do it safely.

Margo Thorning: According to the United Nations, the need for food is going to grow about 30% globally over the next several decades. And since U.S. manufacturing supports food production through technology, machinery and equipment, how much is that likely to strengthen the sector?

Gary Hufbauer: The key to answering this growing demand for food is to have freer trade in agriculture, because agriculture is the way you transport water, as agricultural products are a way to transport large volumes of water from water-rich areas to water-poor areas in the world. Many areas are going to be afflicted by drier conditions going forward. So hopefully, on the policy front, we'll make some inroads on all the barriers to agriculture trade. If the United States remains a pretty good bread basket, then yes, our technology plus our machinery will strengthen the manufacturing sectors. I'm optimistic that we're not going to hit a period of big food shortages globally provided we follow the right policies.

The Chances for Budget and Tax Reform

Margo Thorning: I know we've touched a bit on tax policy already, but I want to finish by asking about the real prospect for change. What in your views is the outlook for major tax reform, perhaps along the lines of Bowles-Simpson or one of the other plans out there, in the new Congress?

John Taylor: Well, that sounds like a political question. But I think the opportunities are increasing. The president has indicated his desire for corporate tax reform. I think more and more people are recognizing the merits of Simpson-Bowles proposals on reducing marginal tax rates. And Gov. Romney is obviously proposing things in that direction. A lot of the stuff in the House of Representatives is in that direction. And of course the need is there, as Gary said, on the corporate side, but also on the personal side. We haven't had a tax reform since 1986 of any significance. And I think the time is ripe and people recognize it, because of the slow recovery. The only question is whether we can deal with it politically.

Jared Bernstein: That is the question. But let me tell you, we will not have tax reform as long as there is a large enough group of legislators to block such reform, who refuse to consider any new tax revenues as part of the deal, full stop. It won't happen. Bowles-Simpson, which has been touted by many, including John just now, raises $2 trillion of revenue over 10 years. I completely understand that it's going to take action on the spending cut side as well. I'm not saying this has to be one-sided. In fact, it's only been one-sided so far. There's over $2 trillion of spending cuts on the books so far. I can only say about those lawmakers who signed a pledge not to raise revenue, you can't go there. Let me be clear: As long as legislators refuse to countenance anything on the revenue side, there won't be tax reform.

John Taylor: Let me respond to that because it's very important. First of all, the idea that a stronger economy cannot generate more revenue is wrong. So if you have tax reform that could be revenue-neutral, that's going to increase economic growth. There's really not disagreement, I believe, that higher growth is the real way to generate more revenue. And the second thing is I think the opportunity to have revenue-neutral tax reform is quite clear, because, as recently as 2007, we have had federal spending as a share of GDP that was 19.5%. In 2000, it was 18.2%. All we have to do is get spending back to the share of GDP that it was in 2007. And you can basically balance the budget with a revenue-neutral tax reform.

Jared Bernstein: But John, you probably agree with me that, just at a political level, without acceptance of new revenues, it's hard to imagine tax reform going anywhere.

John Taylor: Well I don't agree with that, because economics tell me that's not the case. So you know, compromises can be done in different ways.

Jared Bernstein: We disagree. We should let Gary get in here.

Gary Hufbauer: Well, thank you. First point, I agree that it's a total abdication of congressional responsibility for members of Congress not to make hard decisions on options for deficit reduction. Second point is that it seems to me—and I hear what John is saying about scaling back expenditures to, let's say, 20% of GDP at the federal level—I don't think that's possible. With our aging population and the commitments already made in the health care area, plus Social Security, it's a very tough job. Add to that the cost of the wars we've been fighting, and the future cost of proper support for veterans. With all this, I really think it's going to be hard to get federal expenditure below 23% or 24% of GDP, even with drastic cuts in entitlement promises going forward.

So I see a permanent gap between realistic revenue under the present tax system and foreseeable spending. The gap has to be filled in some way. Every other country, I think almost without exception, is filling this gap with a value-added tax or some other national consumption tax. I know that's not in the U.S. political debate now and probably will not be on the table next year either. So I don't know how we will begin to close the looming gap, say, four percentage points of GDP. I do think we're going to need new revenue sources going forward, even if we succeed in scaling back the growth of entitlement spending.