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Pressures Mount for the U.S. Economy

Interviewee: A. Michael Spence, Distinguished Visiting Fellow, Council on Foreign Relations
Interviewer: Christopher Alessi, Associate Staff Writer, CFR.org
June 11, 2012

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The dragging U.S. economic recovery was dealt another blow after jobs data for May, released June 1, showed an increase in the unemployment rate to 8.2 percent (CBS). The U.S. economy is simultaneously facing mounting external pressures related to the ongoing eurozone sovereign debt crisis and a growth slowdown in the developing world. "You have extreme uncertainty and macroeconomic risk in the global economy, which shows up in volatility in a variety of financial markets," says CFR's A. Michael Spence. "This has created uncertainty, and that then causes conservative behavior on the consumption and investment side." Spence also faults Washington for continued political gridlock. "There isn't very much aggressive public policy or public investment action, even taking into account the constraints of a sensible fiscal rebalancing program," Spence argues.

Can you give an overview of the U.S. economic picture in light of the May jobs report?

There [are] two things going on in the American economy post-crisis. One is deleveraging--leveraging up was an aspect of the dynamics that went into the crisis. That's fairly far along, depending on which sectors you're talking about. There are still issues, and the housing market's not helping. The other is structural adjustment of the economy, and that involves both demand and supply-side changes--so the demand side is going to have to eventually rely on a different mix of domestic demand and external demand and a different mix of investment and consumption.

There are signs of market-driven structural adjustment. Wages and incomes are flat. There are some bits of evidence that manufacturing is recovering, and even manufacturing exports are getting a little more competitive. Exports have actually grown above their pre-crisis levels, and imports have not grown the same amount, so the current account deficit is coming down. So all of this is a lengthy process with a really big problem on the employment side, because underneath it all are all these labor-saving technological and global market forces.

You've got a double problem: to pay for past excesses and try to invest in things that will generate growth and employment in the future.

Employment was always going to be a struggle because of these global forces. We really haven't had a recovery in the construction sector, which is labor-intensive and important. And finally, nothing much is happening in Washington. There isn't very much aggressive public policy or public investment, even taking into account the constraints of a sensible fiscal rebalancing program that would make the restoration of a sustainable pattern of growth, employment, and momentum faster, and the quality of the result better.

What policy prescriptions would you recommend the U.S. take to alleviate the employment piece and the larger economic situation?

I don't believe you can solve a structural problem overnight. By structural, I mean where it generates employment, where it's competitive on the tradable side. If you've taken a terrific wallop, in part because you were in a defective growth path--meaning one that's self-limiting, can't go on forever, and includes overconsumption and leverage--then you've got a double problem: to pay for past excesses and try to invest in things that will generate growth and employment in the future. That's a pretty big burden, and it's a hard problem, but the main thing is you've got to decide how the burden gets shared.

We have to find a somewhat fairer way to share the burden rather than just impose it on the unemployed, especially the young--redistributing income to the extent we can, going after skills upgrading and retraining.

The political process [involves sitting down and deciding] who's going to pay the bill. If you don't do anything, then the unemployed pay the bill. We have to find a somewhat fairer way to share the burden rather that just impose it on the unemployed, especially the young, redistributing income to the extent we can [and] going after skills upgrading and retraining. You want to plan to invest in infrastructure. We need a change in attitudes about labor [that encourages investment in the labor sector by focusing skills and job training]. Tax reform would be a good thing that doesn't necessarily cost money.

How is the United States being affected by the eurozone crisis and the slowdown in the developing world?

Adversely. Europe is our biggest trading partner, so the slowdown in Europe is a direct negative effect. The emerging economies are an important growth engine, so their slowdown is not positive either. Then you have extreme uncertainty and macroeconomic risk in the global economy, which shows up in volatility in a variety of financial markets--exchange rate volatility, the Asian stock markets are highly volatile, and even ours is even relatively volatile. All of this has created uncertainty, and that then causes conservative behavior on the consumption and investment side, so that doesn't help either. There's nothing that's happened yet that's a massive hit to the American economy, but it doesn't help that everybody is slowing down at the same time.

What policy prescriptions would you give for the eurozone situation?

Greece may or may not decide to exit. That can cause contagion that's sort of similar in general terms to the contagion that occurred in the Asian crisis in the late 1990s. That has to be contained or it could get out of hand, and that means deploying the European funds [the European Financial Stability Facility and the European Stability Mechanism] and the ECB to stop it. They have to stop it on two sides: the banking side to prevent financial distress, but also on the sovereign debt side. Properly responded to, Greece does not have to bring down the eurozone.

There's nothing that's happened yet that's a massive hit to the American economy, but it certainly doesn't help that everybody is slowing down at the same time.

Italy and Spain are large, and they both need fiscal rebalancing and reforms that are designed to restore their growth, and those go together. It's hard to restore stability and balance on the fiscal side without some growth momentum. What will make this go wrong is if the political systems in Spain and Italy turn against the euro and reform process and say, "We don't want to play this game, we're going to play another game." Then the game is over with respect to the eurozone as it was envisaged.

What's the next step in coordinating a coherent response to the debt crisis?

These reforms take time to take effect. Even if they're getting it done, there's a risk that the yields will run up, because private investors are still uncertain and afraid and not really investing. Most of the money that goes into European sovereign debt is going into the German sovereign debt and a little bit in the Nordic countries. So Germany and the ECB are very reluctant to intervene in the sovereign debt market. But I believe that they will intervene to prevent a flip to a bad equilibrium, where expectations shift the mark, the yields run up, it destroys effectively all the fiscal consolidation that's been done, and eventually shifts the incentives of the countries that are in trouble or need rebalancing.

The ECB has a mandate to intervene in the banks to prevent extreme financial distress. They have done that on a fairly massive scale, and they're prepared to do that again--but their willingness to do that is heavily based on serious commitment to reform in these countries. So it's a kind of chicken-and-egg problem.