September 1, 2013

The Annual Economists Roundtable: Pulling Up

Energy, housing, manufacturing and even customer spending hoist a slow but steady recovery

The distinguished economists who formed our fourth annual roundtable agreed: Though it may not seem like it at times, the American economic recovery continues steadily.

Margo Thorning, chief economist for the American Council for Capital Formation, invited Gary Burtless from the Brookings Institution, Robert W. Hahn from the University of Oxford and Roger B. Porter from Harvard University to participate in the roundtable. Their wide-ranging discussion included the important impact that information technology will have on manufacturing; the reasons why we may not really have a shortage of American science, technology and engineering graduates; and a critical look at our increasing deficits and long-term unemployment. Perhaps it is a sign of an intriguing consensus among experts that, despite their philosophical diversity, the economists seemed to agree far more than disagree on the critical issues facing our economy.

Margo Thorning: I’d like to start by getting your views on how the U.S. economy is doing. We’ve recently seen some numbers from the International Monetary Fund suggesting U.S. growth rates may not be as rapid as some other projections showed, like those of the Congressional Budget Office. So what do you think is realistic? What should we expect over the next several years for U.S. economic growth?

The Roundtable

Gary Burtless holds the John C. and Nancy D. Whitehead Chair in Economic Studies at the Brookings Institution in Washington, D.C. Before arriving at Brookings in 1981, he served as an economist in the policy and evaluation offices of the Secretary of Labor and the Secretary of Health, Education and Welfare during the James Carter administration. He does research on issues connected with poverty and income distribution, public finance, aging, labor markets, social insurance, and the behavioral effects of government tax and transfer policy. His books include Globaphobia: Confronting Fears about Open Trade. Burtless graduated from Yale College and received a Ph.D. in economics from the Massachusetts Institute of Technology.

Robert W. Hahn is Director of Economics and a Professor at the Smith School of Enterprise and the Environment at the University of Oxford. He is an associate at Nuffield College and a senior fellow at the Georgetown Center for Business and Public Policy. From 1999 to 2008, Hahn served as the director of the American Enterprise Institute-Brookings Joint Center. Previously, he worked for the Council of Economic Advisers during the Ronald Reagan administration. He has served on the faculties of Harvard University and Carnegie Mellon University. His books include Reviving Regulatory Reform: A Global Perspective. Hahn received a B.A. and an M.A. from Brown University and an M.S. and a Ph.D. from the California Institute of Technology.

Roger B. Porter is IBM Professor of Business and Government at Harvard University’s John F. Kennedy School of Government. He has served for more than a decade in senior economic policy positions in the White House, most recently as Assistant to the President for Economic and Domestic Policy during the George H.W. Bush administration. His books on economic policy include Efficiency, Equity and Legitimacy: The Multilateral Trading System at the Millennium. An alumnus of Brigham Young University, Porter was a Rhodes Scholar at the University of Oxford, where he received his B.Phil. degree. He received an M.A. and a Ph.D. from Harvard University.

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 Times, The 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.

Gary Burtless: I think the IMF forecast is greatly informed by its appreciation of what is going on in the developing countries. And a couple of those countries have run into headwinds recently—I’m thinking of Brazil and China. A slowdown in these developing countries is going to slow expansion here in the United States.

But people who have been in the business of making economic forecasts have been predicting an upturn in the U.S. growth rate two or three quarters down the road or maybe in the next calendar year for the past several years. Yet what we have actually seen is a moderate growth rate. We haven’t seen any sustained period of exceptionally rapid growth. And I think the pessimists think that this is the new normal. We just will not have the big rebound from a very deep imbalance in the economy that we have seen in the past several recessions.

Robert Hahn: My sense is that, over time, we will come out of this. I leave it to folks at places like the IMF and the World Bank and the CBO to guesstimate what growth rates might be. The way they do that generally is to extrapolate based on linear models. And the big problem is that we had a major structural change in 2007 and 2008, so the models aren’t terribly informative.

Roger Porter: I share the view that forecasting the future is very hard to get right, even with the best of intentions and the best of models. However, I think there are a number of reasons for cautious optimism and a number of cautionary notes as well. First, the reasons for cautious optimism. The housing sector, which contributed so heavily to the downturn that we had in 2008–2009, has now turned. Home prices have been rising at double-digit levels nationwide. New home construction is also up sharply. And this improvement in housing is reflected in increased demand for durable goods.

Second, we’ve got a big potential benefit from a significant increase in domestic energy production associated with shale oil and natural gas. It is not beyond the pale that the U.S. could be a net energy exporter by the end of the decade. We’ve got a lot of increased energy production and investment on a scale approaching $100 billion. And this will not only help our energy situation, but also create jobs and lower oil and natural gas prices and also likely lead to increased consumer spending and some help to our manufacturing sector. Third, we have seen some substantial improvement in household and corporate and financial institution balance sheets since the severe downturn we had around 2008–2009. We had a big plunge back in 2007–2008 where net wealth dropped by about $13 trillion. Most of that is now back and recovered.

However, there are some cautionary notes as well. One, we’re still running very large governmental deficits. We have now accumulated at least $17 trillion of debt, all of which needs to be financed. And the very low interest rates that we have enjoyed recently have potentially lulled us into a sense of complacency because if you look at what our budgetary situation would be, were interest rates to rise, that would have a huge impact on the federal budget—and a negative one indeed. Second, we’ve seen a big shift, largely for demographic reasons, from discretionary spending into entitlement spending. And the characteristic of entitlement or mandatory spending is it dramatically reduces your flexibility and capacity to direct resources to productive uses, such as research and development and infrastructure investments. So the accumulation of debt is going to have to be financed, plus the inexorable rise in entitlement spending is going to put further and further pressure on discretionary spending by the government.

Inequality, unemployment and a declining middle class

Margo Thorning: Is the disappearing middle class—the apparent growth of inequality—a real phenomenon? What are the implications of this for our economy? And what about the potential long-term unemployed situation for so many young people, as well as people in other age brackets?

Gary Burtless: I think that the middle class is a long, long way from extinction. But its prosperity has certainly taken a body blow since 2007. The net incomes of middle-income people are still below where they were in 2007. The middle class is certainly not going to be in robust good health until we shrink the gap between where the economy currently is and full employment, and we’re a long way from that. And as long as there is this burden of excess unemployment, we’re going to see very, very slow growth in compensation and wages received by middle-income people. A lot of the gains in U.S. income since the low point of the recession have accrued instead to businesses and to people who have very good perches in our economy.

Roger Porter: The most important thing that we can do for middle-income Americans is to generate greater economic growth and more jobs.

Margo Thorning: What about the chronically unemployed? We see statistics that there might be really 15 million unemployed at this point. What are the implications of a large number of people who are able to work yet aren’t working?

Gary Burtless: Unfortunately, employers do not like to hire the long-term unemployed. They see a long period without work as a big negative in the hiring process. And so what those folks have to hope for is that the economy expands strongly, which, so far in this recovery, we have not seen.

Robert Hahn: I think unemployment and particularly youth unemployment is going to be a very large political problem. I can’t judge how big in the United States. But I can tell you it’s very large in Europe, both in terms of size and in terms of its political importance. But it’s not clear to me how politicians are going to respond. I would be surprised if we did not see some programs in the United States being offered by politicians on both sides of the aisle to deal with this issue in addition to just hoping that growth brings us out of it.

Gary Burtless: I hope Bob is right about the political necessity or will to do something about it. It’s amazing how democratic institutions accommodate themselves to high prevailing rates of unemployment. Yes, there are some election upsets. Governments are tossed out. But when things are improving, albeit slowly, often that seems to be enough for middle-of-the-road voters to think that the government they have or the policies that they see are tolerable ones. And so a lot of young people are accommodating themselves to the high prevailing rates of unemployment by settling for worse jobs and by staying in school longer than was the case in 2007. There has been a very sharp fall-off in labor-force participation rates in the American population that’s under 24.

A housing bubble?

Margo Thorning: Since housing has been one of the strengths of the current recovery, do you think we’re heading for another housing bubble?

Roger Porter: I am skeptical simply because lending patterns with respect to housing have changed dramatically since the housing bubble that we had in the last decade. We have no loans that are being made today with the loose conditions that were commonplace in the past. Lenders are much more careful and much more cautious than they were, as are borrowers.

Gary Burtless: That’s right, and often it’s very hard to repeat a bubble so soon after there has already been a bubble in the same asset class. The memory of the optimism that people had, based on the expectation that any asset they bought was going to be worth more next year and five years down the road, is a lot harder to sustain when you have a lot of potential buyers who vividly remember the losses sustained by people who held that belief just five years ago.

Robert Hahn: I think that the expectation of a rise in interest rates or the actual raising of interest rates is going to put a damper on the level of price inflation we’ve seen in housing over time. And I also agree with Gary that most folks have a very strong memory of what happened. That’s not to say we’re not going to see cycles in the housing market over time. But I’m not worried about a so-called bubble being around the corner.

The impact of energy and information technology

Margo Thorning: What are the most important technological innovations that will affect our economy, particularly manufacturing, in the next five to 10 years?

Robert Hahn: It’s fracking, the hydraulic fracturing of oil and gas. This technology is going to have a huge impact on the U.S. economy. It’s already starting to—and on the world economy and just the nature of energy prices throughout the world. Obviously, to the extent that energy is a significant component of manufacturing, that’s good news for manufacturing in the United States and other places that have access to this technology.

Roger Porter: I would totally agree that the area most likely to experience manufacturing technological changes is the energy sector. A lot of resources are going into that now. And the likelihood that we’ll see major changes in that over the next decade is quite strong.

Gary Burtless: It’s also hard to overlook a constant that we have seen for the last 50 years, and that is the ever-decreasing cost of good information technology and all of the fields that touches on, including communications and inventory control. Those improvements just keep making information technology cheaper and cheaper relative to everything else. It certainly reduces the cost of doing lots of things that formerly we would’ve thought could only be done with human power and human reasoning and skilled human intervention.

Roger Porter: I would underscore that and add that it has reduced the number of mistakes that get made in manufacturing processes and things that need to be done and redone. That qualitative improvement has huge cost implications for the manufacturing sector of the economy that’s actually doing very well these days.

Immigration and the alleged STEM-worker shortage

Margo Thorning: As you know, immigration reform is quite a hot topic here in Washington. And many corporations are very interested in seeing an expansion of the visas for highly skilled workers. The conventional wisdom is that we need to allow more of these people into the U.S. But studies by the National Science Board, American Chemical Society and others suggest that we may have a glut of American citizens already in these fields. What accounts for this disparity? And what are your views about what’s needed in terms of immigration reform?

Gary Burtless: The simplest explanation is the profit motive. Employers have a very one-sided bargaining position with employees who are in the United States with temporary visas. In many cases, those visas do not even permit the immigrant worker to change employers without losing the visa, and that kind of bargaining power that the employer enjoys is not anything like the bargaining power they have with regard to their permanent visa holders and their citizen employees. So it’s not surprising they would really prize having a lot of highly trained technicians and workers over whom they have this kind of influence.

Robert Hahn: If we were to have a complete open-door policy throughout the global workplace, there are estimates that say you could double the world’s GDP, moving from something like $70 trillion to $140 trillion. I recognize that no one in Washington or Brussels or Beijing or wherever is talking about that. But there are a few kinds of reforms that you can think of that would have amazing increases in economic efficiency on that order.The views of the science and engineering representative groups, of course, are motivated by wanting to have as good wages and working conditions for their members as they possibly can. And it is difficult looking at the employment and unemployment statistics to say, “Oh, well, the engineers and the technicians have escaped the effects of the Great Recession.” They haven’t. Their unemployment rate went up. So both the employers and the groups that represent engineers and scientists are correct.

So why do politicians resist this? There are fairly strong, sometimes well-organized constituencies that believe that their wages or their employment is going to be affected. But studies of immigration find that immigrants on average create wealth and jobs both in the country they’re coming to, whether it’s the United States or the U.K. or elsewhere, and in their country of origin, through remittances. So from an economic point of view, I think it’s pretty clear that there are efficiency gains from lowering barriers to entry. But I don’t know how to handle the political problem.

Roger Porter: I would simply add that one of the key features of the United States is that we have a very strong post-secondary education system, which attracts talent from all around the world. It is almost mind-boggling that we then take people who have been trained here and would like to stay here, and often make it difficult for them to do so when they constitute a major investment in human capital. And many of them tend to be highly entrepreneurial in nature. Many of the new companies that are formed each year, and that ultimately succeed, are from first- or second-generation immigrants. We need to help facilitate the kinds of skills-based immigration that have benefited us and other countries in the past, and can continue to do so in the future.

Regulation? It’s complicated

Margo Thorning: Let’s move on to the U.S. regulatory system and its impact on economic growth. Do you see an upward trend in regulations? And if so, what do you think the impacts are?

Robert Hahn: The answer is, it’s complicated. I don’t have a one-liner. Do you see an upward trend in regulations? Well, certainly if you look at things like the Federal Register, the number of pages tends to go up over time. But I don’t think that really tells you anything. And I think that most people would agree that over time we’ve become a more highly regulated, in some ways more litigious, society.

We want to be moving toward smarter regulations. So we would like to be applying serious benefit-cost tests to regulation. We’d like to be simplifying it. We’d like to be looking at older regulations as the Obama administration claimed it was doing (but I’m not sure what it’s actually doing) and getting those off the books if they don’t make sense. For reasons that many have pointed out, the U.S. does have a natural tendency to add on regulations over time, and it’s hard to take them away. But we have taken them away in big sectors of society. We actually deregulated the railroads, and we deregulated the airlines and some other areas, and have had very positive effects. So I think it’s a mixed story.

Roger Porter: I would concur that it’s a very mixed story. Part of it is that we live in a time in which there’s a great desire to reduce risks in life and risks in the economy. And as a result, over the last several decades, we’ve had a great deal of regulation dealing with health, safety, the environment in order to achieve various social values, as well as a good deal of economic regulation to attempt to enhance the safety and soundness of financial institutions, among others.

Whenever we wade into this area, there’s always a challenge in balancing a host of considerations. What’s the likelihood of effectively achieving your desired goal? What is the cost in time and resources to those who have got to comply or enforce it? What is the ease or difficulty of implementing it? And not least, what are the ancillary effects on economic growth and innovation? And there’s a tendency to respond sharply in the face of a negative event, such as the financial difficulties that we had in 2008 and 2009. But sometimes we overlearn, and other times we tend to return soon to past practices. So there often tends to be this overreaction and overresponse.

There’s been a massive increase in the oversight of our financial institutions, and this has led to a lot of time, effort and resources being devoted to activities for which the gains are relatively marginal. There is no question that the modern economy requires an appropriate and adequate level of regulation. Getting that right is rarely easy and requires a lot of vigilance and really sound benefit-cost analysis, so we are aware of the true cost and benefits of what we are doing.

Gary Burtless: I’m sure that there are shareholders in AIG insurance that wish that the employees and the executives of that company had been subject to a little bit more regulation in terms of the kinds of implicit insurance contracts they were writing on very risky kinds of assets. Those shareholders lost more than 90% of their equity investments in that company. And part of the reason was that they could write insurance contracts without owning sufficient assets to back up those insurance contracts. And the federal government famously had to step in and rescue that company. And there are lots of regulations that in retrospect we wish had been zealously enforced or had been on the books. So it is not always clear that the absence of regulation means the greater perfection of a capitalist country.

I do think that the complexity of the modern economy means that there are a lot of actors in that economy who have too little information on their own to decide what is prudent and what is a good, safe transaction, and therefore regulation is going to help make transactions safer and better.

Tax reform: badly needed and hopelessly stuck

Margo Thorning: What do you see are the chances of major tax reform this year? What are the most important reforms that would benefit the manufacturing community?

Roger Porter: I wish I could be more optimistic about the prospects for tax reform because I think there is widespread consensus in many quarters that we need a tax code and a tax system that are much less complicated and much more streamlined than what we have now. But it requires sustained political leadership to pull it off. I don’t see that available now.

We’ve had over 3,000 legislative changes in the tax code since the year 2000. A more simple, stable tax code would facilitate planning for corporations and individuals, reduce overlapping and confusing requirements, increase the likelihood of compliance and eliminate opportunities to game the system. People in the business community tell me the No. 1 thing on their wish list is to simplify the tax code. They spend enormous amounts of time, effort and energy trying to comply with it and make sure that they don’t pay any more than is absolutely required. This is counterproductive for the kind of economy that we want now. I am afraid, though, that the prospects for it today are pretty modest.

Gary Burtless: I’m not very optimistic either. For a lot of manufacturing companies with international operations, tax issues are critical. For many of these firms, the corporate income tax in the United States is slowly becoming, at least in some measure, a voluntary tax. Through adroit transfer pricing and legal arrangements in a variety of different countries—Ireland comes to mind, but there will always be some, somewhere—firms can make it appear that a very sizable percentage of their net income is earned in low-tax jurisdictions, regardless of what the economic realities are. So the question is whether the corporate business tax, as we understand it in the United States, can survive for two or three more decades. And I don’t know what the answer is.

Obamacare and its implications

Margo Thorning: Let’s talk briefly about the impact of the Affordable Care Act, which, as you know, is going into effect in 2014. The administration has begun to step back a little bit, delaying penalties for large employers. What do you think the compromises might need to be?

Roger Porter: A workforce that feels it’s valued and respected is invariably more productive. And one way of communicating value to employees is how they’re treated with respect to benefits, particularly health care and retirement. Almost all large companies provide health insurance for their workers. Many companies realize that they could opt out and pay a fine, and it would cost less than what their current health insurance cost is. Most are reluctant to do that because of the signal it would send and the difficulty that it would present in recruiting workers in the future.Gary Burtless: So far the Obama administration has tried to make its decisions in a way that are respectful of the burdens on business. By postponing for one year the assessment of any penalties whatsoever on large firms, they took a practical step. In general, in a world where there is very high unemployment, they have been making regulatory decisions in order not to discourage employment growth.

But in the new act, you’ve got a couple of big problems. One is businesses whose size hovers around 50 employees. Whenever you draw a line that exempts those below it and includes those above it, you’re always going to have an effect on behavior. And how to deal with that is very difficult, and how to deal with it successfully is not clear. Similarly, when you establish a cutoff point of 30 hours for full-time employment and less than 30 hours is part-time employment, then you create a set of incentives that are going to affect behavior. And this is in a sector of the economy that is now huge.

Health-care spending is upward of a sixth of gross domestic product now. Getting this right is going to be extraordinarily difficult, and it does not surprise me that there’s been a delay with respect to the employer mandate because I share the view that I understand Gary has that the people who are doing this have the best of intentions, but it is an extraordinarily difficult task to get right.

Gary Burtless: In the United States today, we spend about 21 cents out of every dollar of personal consumption expenditures for health care. No country in the rich world spends nearly that share of their personal expenditure on health care. This may be an area where capitalism completely fails. And more government direction, in other places, has yielded a better combination of quality of care and low price of obtaining that care. The countries that tend to have the most centralized control over what providers can charge for the services they provide also tend to have the lowest costs. It is very unclear whether they get less good care in exchange for those much lower prices that they pay.

Roger Porter: As Gary points out, it is true that we have way more health care provided in the United States than in many other countries. And part of the reason is the series of lifestyle choices we have made. The Department of Health and Human Services estimates that over half of the health care provided in the United States would not be needed if people made different lifestyle choices. Japan has about 4% of its population who are obese. We have 34% in the United States. So when you start making cross-national comparisons, we provide way more health care per person than many other countries.

Robert Hahn: I don’t think we really let a reasonable market in health care develop in the United States. I don’t think you can conclude reasonably, for example, that the U.K. system, say, because it takes a lower fraction of total income and gets comparable results, is necessarily better than a market-oriented system that an economist would design—not necessarily the system we have in the United States, which I don’t think can be fairly characterized as a market system.

Gary Burtless: I agree with that. But even though employer contributions for health benefits are deductible to the employer, you would think that the employers in a wonderfully functioning capitalist economy would be negotiating with their insurers and with providers to get the lowest possible price consistent with giving their employees excellent care. And that is what seems not to be working in the United States. Why shouldn’t they be pushed to get the best possible deal for their employees? Medicare gets better prices than the private insurers do when they are representing private employers. And Medicaid gets the lowest prices of all. It is really a problem of the employer-financed health insurance system in the United States. It is not getting the good deals that the patients and taxpayers receive in other rich countries.

Margo Thorning: I think we’ll end on that note. Thank you all so much for taking the time for this. We appreciate it very much.