Thursday, March 4, 2010

Roadmap for America: paralleling Asian overinvestment with American overconsumption, and what needs to happen next

The inimitably masterful Michael Pettis had an article yesterday about Japanese rebalancing and why it hasn't worked out as planned.

To summarize and expand on what Pettis said, basically, he argues that the Japanese have had two miserable decades largely because they allowed debt-fueled investment to swell to a massive proportion of GDP, and when debt constraints and a reduction in additional economically-worthwhile projects (because the good ones were already being done) kicked in, the government was too slow to adopt policies (largely regarding currency pegging and changing patterns of taxation, subsidy and government expenditure  - basically, monetary and fiscal policies) that allowed consumers to shoulder more of the burden of GDP growth. Thus, GDP growth slowed down as investment slowed down (less than it would have with new policy, but slowed down) and consumption never kicked in. My corollary is that net exports couldn't keep going up, because they were already crushingly high, and government spending is extremely inefficient - perhaps more so in Japan even than it is in the US.

Reading this gave me some interesting, and somewhat concerning, ideas. Debt-fueled anything can never sustain a growth rate for a long time. Leverage can be a wonderful thing in temporarily improving a growth rate, but to paraphrase one of Warren Buffett's favorite quotes, when something cannot go on forever, it must stop.

Just as Japanese overinvestment could not last, American hyperconsumerism and Chinese hyperinvestment cannot last. They are certainly linked, to a large extent, but they're also parallel. I've talked a lot about the Chinese overinvestment and the associated debt, real estate and commodity bubbles it has created, so here I'll talk about American overconsumption.

Americans have absolutely consumed more than they're capable of consuming in the long term, which is evidenced by the tremendous increase in household debt levels. However, consumption and investment are a little bit different from one another, because consumption is less persistent than investment. Thus, unlike investment, where when you build a railroad between two places, that railroad can last for 50 years without substantial further railroad spending relative to the initial cost, you can actually reach a sustainable consumer equilibrium without a catastrophic drop in consumption spending. Certainly, the portion financed by debt needs to go away, and without additional debt availability, the savings rate needs to be above zero, but if we had a long-run consumption slightly above what we have now (if more workers were employed in non-consumption-oriented pursuits, but the savings rate stayed at the 4% or so it is now), we could certainly avoid the Japanese problem (or America in the 30s problem, or upcoming China problem) of having to wait until the population fills out or wears out prior investment spending while desperately trying to reduce the overall debt level and simultaneously maintaining government spending to avoid deflation and GDP drops - that's going to be a difficult and very unpleasant situation for China. It took a massive monetary jolt (getting off the gold standard) and a world war to get America out of its depression, and the Japanese haven't really emerged from theirs because they couldn't stimulate consumption very well. Because the US was driven by overconsumption, we'll be in better shape than they are - investment is, in a sense, "easier" to deal with because it requires less government heavyhandedness in providing safety nets for people to spend their savings on consumption.

The question, of course, is whether "better shape than they are" is good shape (US, 1950s and 60s) or merely mediocre (Europe 1970-present) shape. It is possible that we could plod along without a lot of growth, Europe style. Remember, consumption spending can't rise much more and government spending is very, very inefficient, esp because prospective future taxation at some level should make people spend less now. Relying on government spending to drive GDP has never really worked for anyone as an economic policy - it can be very useful in crisis control, but it's something that should be weaned off. Most of heavy-government Western Europe hasn't grown in 40 years; the major exceptions are either financial capitals driven by profits from increasing worldwide leverage and low government intervention (Luxembourg and Switzerland), countries driven by spending leverage and massively reduced government intervention (Ireland and Spain), or countries with major natural resource finds (Norway).

So if our GDP is to continue growing, and consumption can't drive it, and government spending is a brutal lever, then the alternatives are increasing investment spending, increasing exports or decreasing imports (without correspondingly decreasing exports, as would happen with a trade war).
So how do we do that?
Short of a major natural resource find relative to the size of our economy (which is possible for a small country like Norway but not really for a big one like the US), the easiest to achieve is decreasing imports - an import certificates plan would accomplish that. I've mentioned this a great deal, but the general gist is that each imported good should be assigned a tax exactly high enough to offset a trade deficit. If the trade deficit drops, the tax drops (which is why it's so far superior to tariffs). Doing this on a currency by currency basis would be one option, but it would be better to allow trade imbalances with some countries as long as it balances out overall - if China has a substantial comparative advantage over Europe (or wishes to duke it out with Europe and steal its consumption), then all the better for America to be able to run a current account deficit with China and an offsetting surplus with Europe - we get more goods for each dollar while still maintaining trade balance. Europe gets weaker and China continues its export strength, but that's a problem they are more than capable of working out themselves.

An equivalent idea that could be easier to implement is one that I read on interfluidity (, which would target not the goods being traded but the equivalent capital flows. If we import an extra billion dollars of goods each year, we export an extra billion dollars of capital (dollars - basically, claim checks on future US goods). When we send dollars overseas to finance our goods, those dollars get invested in US financial assets - stocks, bonds, treasuries, etc. Taxing the investment of dollars into dollar denominated assets by foreign holders of dollars at an exact level to offset the trade deficit would be equivalent to taxing goods. Both are difficult things to do, but the capital control may be easier to implement. The major trouble would be a purchase of commodities by foreign countries using dollars, because the US can't tax that. If this makes a capital control impossible, then the import good certificate policy would have to be implemented.
Of course, I've made the point before that government spending HAS to drop if the trade deficit does because the government uses a combination of the trade deficit and bank capitalization rules to fund its budget deficit. Heavy taxation is counter to the goal of "keep consumption stable, increase investment and exports and avoid inefficient government spending", so that means spending MUST come down if we're going to avoid rising interest rates that would stifle consumption and investment.
Of course, this means government spending drops. Government spending may be inefficient but it's not completely ineffective, so you give back at least some of the GDP gains from reducing imports when you reduce government spending. Reducing the deficits would be a massive step, and they are somewhat a prerequisite, but they may not be sufficient to jumpstart the country.
This brings us to the "increasing exports" and "increasing investment" side. Increasing exports is related to currency strength, but it's also related to the appeal of US goods outside of the US. Now, increasing exports while we are net importers is useless for GDP growth under an import certificate plan, because itll just be offset by increased imports as the tax decreases (of course, this means that US consumers get to consume more goods for each dollar, which is a massive positive. It doesn't show up in GDP growth but it's still an awesome thing).
The fortunate thing is that we largely don't need to target increased exports in order to achieve it; increased investment spending into exportable but also domestically consumable goods (or increased logistical capability to increase investment spending) will probably increase exports as well with ancillary benefits.
So how do we increase investment?

Otellini outlines a number of the important policies, as I blogged about yesterday. In my opinion, substantial R+D tax credits - like, you can write off up to 10% of your revenue in R+D tax credits and anything beyond that is 75% deductible - would be amazing (and also boost employment of scientists, which would require immigration of more scientists). Capital equipment tax credits would also be extremely useful. Overall reduced corporate tax rates would be useful also, but in a strange way, it may be more beneficial for the country in the long run to reduce corporate tax rates only as much as we need to do be internationally competitive (which is a nonzero number, but not a megacut either), and then "cut the tax rate" conditional on R+D and capital investment - or, in other words, give R+D and capital equipment tax credits, also. Companies that don't invest in any new buildings or equipment and don't do any R+D are largely consumer companies - Wrigley is one example - and we don't suffer very much by keeping their corporate tax rate where it is.
He also doesn't mention the importance of basic research to long term future growth, which has slipped in recent years in both quantity and quality. Corporations outsource more basic research to universities, and we have enough science phDs that we can ramp up basic research funding to universities and have scientists there to conduct it, as long as foreign PhD recipients are allowed to remain in the US (indicating immigration policy needs a change). NSF and NIH grants have been going to older and older (and typically less innovative and more derivative) recipients for years, so mixing in some young people isn't a bad thing for some new innovative work - you get both experience and fresh ideas.
We do need infrastructure to facilitate commerce - ours is very old. Governments generally have to fund this stuff (highways, roads, the energy and water grid, etc). There are plenty of other places to cut spending that are multiples of the size of the requried infrastructure investment, so spending considerations shouldn't be huge here. Getting off of oil will be critical for imports and national security, so this may have to be funded as well.
Finally, we can cut government deficits and spending without hurting the economy if we tax economically destructive goods - smoking being the classic example. Smoking is very expensive (less for the government - smokers tend to die too young to get full medicare benefits - but for the economy as a whole). Taxing smoking raises money for the government while helping the economy. There are many similar goods.
So an integrated list of policies, with expansion on what I've written above, is included. Call this Trevor's "Roadmap for America":
1) import certificates or capital controls. These would need to be gradual so you don't shock the world economy (US consumers, foreign producers) into a temporary catalysis. It also gives the government some time to cut spending.
2) decreased government spending. Means-testing social security and overall defense spending are wonderful targets here, as are increasing the age of eligibility for Medicare and Social Security and indexing them to life expectancy, as should have occurred from the get-go. A more competitive health insurance market would be useful, as well, in reducing the requirements for people to be on Medicaid (note that the current reform bill accomplishes none of these things).
3) Substantial R+D tax credits, capital equipment credits, somewhat lower corporate taxes and better-directed and funded NIH, NSF, NASA and Defense research grants for basic research.
4) Allowing educated immigrants into the country without massive visa hurdles (ideally, allowing more immigrants into the country, period, conditional only on them not committing crimes and having someone in their family be at the very least intermittently employed).
5) Government investment in a) public commercial infrastructure (efficient highways, efficient rail, a more reliable and more "smart" electricity grid, better powerplants) and b) technology/research to reduce reliance on imported oil (cars that don't need gasoline or as much gasoline, for example)
6) Pigouvian taxation of economically destructive goods - Cigarettes, alcohol, trans-fats, gasoline (not just for climate, which is a strong side benefit - the idea here is energy independence for national security and a reduced trade deficit), sugary drinks, perhaps red meat, bottled water, energy-inefficient lightbulbs, appliances and cars, etc.
I didn't write about these at length here, but two more:
7) an enforcement of consumer safety provisions and anti-environmental dumping legislation (to reduce long-term health costs and improve overall consumer welfare, and to generally address the fact that we can still see improvement in this area and it matters for the future productivity of our natural resources).
8)  an education system overhaul, involving vouchers for charter schools and a deemphasis on teachers' unions, would give America a more competitive and efficient labor for generations to come.

No comments:

Post a Comment