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How to Reverse U.S. Economic Malaise

Interviewee: A. Michael Spence, Economist and Recipient of the 2001 Nobel Prize in Economics; CFR Distinguished Visiting Fellow
Interviewer: Christopher Alessi, Associate Staff Writer, CFR.org
June 16, 2011

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U.S. unemployment remains high at 9.1 percent (FT) and expectations are grim for creating sustainable job opportunities. But while it is "probably going to stay high for a fairly long time," public sector investment in education, technology, and infrastructure are a way to tackle unemployment by addressing longstanding structural problems on "the tradable side of the economy," says Nobel Prize-winning economist A. Michael Spence. While the United States also faces a widening deficit and the prospect of default (WSJ) if Congress fails to reach an agreement on raising the nation's borrowing cap -- a scenario that could plunge the economy back into recession -- Spence says the "question of how we're going to preserve future government investment while balancing the budget is getting lost in the shuffle." He also notes that, in terms of foreign policy, the United States is "getting to the point that we can't stay in the role of [dictating] gobal security," and is entering a period in which its "economic power and national influence are going to be more broadly spread out."

Why is employment still so high three years after the financial crisis?

Two reasons. One is that, coming into the crisis, the United States was over-consuming based on the "wealth effect." People thought they were richer, so they started consuming more and saving less. When the crisis hit [spending] dropped back to more normal levels. So part of the problem is that it will take a while because of the damage to household balance sheets. And the housing markets are in great trouble, so people are being conservative, and are trying to rebuild their pension savings and their balance sheets. In an environment where you're short of domestic demand, employment doesn't come back all that fast.

The second reason is longer-term and structural, which is that over a long period of time -- two decades -- incremental employment was in the non-tradable economy, which is where you basically have to produce goods and services domestically, like government, healthcare, and construction. Even before the crisis, we weren't generating any real net incremental employment on the tradable side of the economy. The overall pattern, because of the out-migration of employment at the lower end of the value-added chain [the outsourcing of manufacturing and other jobs abroad], basically means that the tradable sector is not an employment engine. When you add those two things together -- the difficult and extended recovery and not generating employment on the non-tradable side of the economy [the sector where job opportunities had grown incrementally before the crisis] -- it looks like unemployment is (a) high and (b) probably going to stay high for a fairly long time. How long depends on whether we address competitive structural issues on the tradable side of the economy [making that side an employment engine].

Which sectors of the economy are growing?

If you look carefully at the tradable sector, there are parts of it that are growing -- consulting, finance, managing multinational companies, computer design -- that are classified in statistics as separate sectors. It's more the middle-income group [including manufacturers and small business owners] whose employment opportunities are declining in the tradable sector.

Would you say the same of middle-income earners in the non-tradable sector?

The effect there is indirect. For the period in the beginning of the crisis, when we didn't have an employment problem, what happened was, since the job creation on the tradable side was declining, especially for that group, they were employed on the non-tradable side of the economy. That means the supply was larger than it might have otherwise been. So that puts downward pressure on wages and salaries, or at least reduces the increments. That's consistent with the relatively stagnant income growth we've seen in the middle-income group in the United States. And now, the non-tradable sector loses some of its employment-generating capability, and what was a downward pressure on income growth turns into an unemployment problem.

What can be done to facilitate job creation in the tradable sector?

It's a combination of the supply and demand side. At the more macro level, I would characterize the United States economy as under-investing across the board, but especially in the public sector. Parts of educational investment are ineffective; the part devoted to productive-skills acquisition that would support an expansion of the tradable section appears to be questionable, maybe weak. Infrastructure investment has been deficient. Investment in technology has been pretty good, but really not targeted at employment-related things. At that level, we've kind of just been eating our seed corn.

We're low on investment by most measures, and we don't even save enough to cover the investment that we make. That's why we're running a current-account deficit that doesn't seem to be going away. At a more detailed level, people are skeptical about whether we'll be able to do this in a difficult [economic] situation, but we're basically going to have to invest in our future. Another part of it is trimming down, with government business and labor, working out what it will take to expand the scope of the tradable sector and the employment-generating ability. It might take some combination of income growth and public-sector investment, and maybe some insight from the private sector as to where the opportunities might lie. I don't think you could know the answer before you set out on the journey.

Can you summarize the current debate within the United States over the budget deficit and the debt ceiling?

There's a shared view that we're on an unsustainable path with respect to the deficit and the debt level -- and something has to be done about it. We have to restore some sense of balance, which means stop running big deficits, and eventually get the debt level down as well -- which may drain surpluses. That's where we really stand. It's important to know that we've ignored deficits in the past, but they're much more salient politically now than they have been historically.

You have the people who are saying, "We're going to do this by cutting." On the right [of the political spectrum], they're saying, "Well, the government's big enough. We have to cut expenditures of some kind or another until we get to the point where we're back in balance. We don't necessarily need to do it overnight, but on a reasonable time path, say five years -- and no more revenue, no more tax increases." The other side doesn't want to do it that way. It [the political left] thinks that if we're in a hole, then we might want to raise taxes. Expenditures are not just expenditure sheets; some of them create enhanced opportunities in the future; this has some of the characteristics of investment. My impression is that this question of how we're going to preserve future government investment while balancing the budget is getting lost in the shuffle. It's necessary to keep in mind that it's a fragile recovery, that we don't want to cut too quickly and produce another downturn in the economy.

If an agreement is not reached between Republicans and Democrats on raising the debt ceiling by August what are the consequences of a default or delay in interest payments?

There's a large volume of thoughtful opinions across the spectrum that [question how] a country that's the reserve currency of the world and so-called safe haven is willing to play around with whether or when its going to honor its debt obligations; it's risky and irresponsible. It's being used [as a political tool] to try and leverage the discussion about the fiscal situation. But, on balance, for both the United States and the global economy, this is a step we shouldn't take [not raising the debt ceiling].

To what degree can the continued economic slump be tied to policy decisions made in the wake of the crisis? And to what extent can it be attributed to underlying structural flaws that proceeded the crisis?

The difficulty that we're having now is not primarily a failure of policy. The crisis itself was managed rather well. Post-crisis, there was, on the part of market and policy, an underestimation of the structural nature of the recovery. Even today we keep hearing discussions that make it sound like this is a difficult cyclical recovery, as opposed to a long, difficult recovery based on an unusual amount of balance sheet damage. It's never been a normal cyclical phenomenon, because in a normal cyclical phenomenon you just don't have this much balance sheet damage and financial damage.

Given all that, it's hard for me to imagine that there were a set of [different] policies that could have been adopted that would have dramatically changed the course of the economy, say, in the two years after the crisis. What was done, however, was to overestimate the speed of the recovery, to overestimate growth -- on both the part of markets and policymakers -- and that produced some mistakes. There was not enough serious attention paid to the potential fiscal problem until it became clear that we weren't going to get over it anytime soon.

What are the foreign policy implications of the current U.S. economic malaise?

If we're weak economically, it tends to undercut to some extent our ability to exercise power in the global economy. There's a sense that we're getting to the point that we can't stay in the role of [dictating] gobal security and foreign policy. We're entering a period in which our economic power and national influence are going to be more broadly spread out. And we'll need help to manage the whole operation in terms of security and economic balance and sustainability -- but we're going to have to figure out how to do it together, without being a dominant player. That'll be a big adjustment in the way we think.

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