You might not know it from what passes for economic commentary on cable TV, but the U.S. economy remains pretty sick. Last week’s report of 3.5 percent GDP growth in the third quarter seemed like cause to celebrate – until you looked more carefully at the data and saw that virtually all of the upside came from temporary government stimulus. As the head of a revered British firm told a crowd of fellow CEOs in Washington the same day, “if we gave that many drugs to a dead man, he’d dance too.” The next day, the report on personal incomes showed consumption continuing to slump, along with incomes. In coming months, the media and the administration will trumpet more reports of “good news” which actually will provide little comfort to most American businesses and households. GDP may grow even faster in the fourth quarter as the stimulus continues to run its course and businesses stop cutting inventories that already are down to the bone. After that, we could yet face a second dip down, a possibility raised last week by Harvard economist Martin Feldstein.
We could even face more upheaval in financial markets already growing giddy again. In fact, Nouriel Roubini, the NYU economist who warned us in 2006 and 2007 that the end of the housing bubble could wreck the financial markets, now sees a new bubble forming from trillions in new investments by financial institutions playing the declining dollar off of other currencies. Moreover, he also sees an inevitable bust coming, with devastating new costs. He’s certainly correct that currency plays are very risky, since exchange rates can turn unexpectedly on a dime. That’s actually a variant of what happened to the Long Term Credit Management fund in the late-1990s. The big bets placed by that single fund, and the liabilities of its Wall Street investors, nearly brought down the financial system. What’s happening now is on a much bigger scale, and the underlying system is a lot more vulnerable.
If we do dodge Roubini’s latest bullet, the bad news eventually will run its course – though it probably will take at least another year, and longer than that for employment to recover. By that time, it will be more obvious that we don’t have a national strategy to avoid another boom-and-bust cycle and produce sustained gains for most people. It’s hard to face, but the Treasury and Congress have to give up their comforting assumption that the handful of financial institutions which dominate our capital markets are driven to behave in ways that ultimately produce good times for everyone. In some periods, markets do work nearly as well as that – from the latter 1950s and through the 1960s, for example, and again in the latter 1980s and through the 1990s. At other times, distorting new conditions bound the system, and markets go a little haywire. That’s what unfolded in the latter 1920s and through the 1930s, again in the 1970s, and now it’s happening again. So it’s time to retire the economic strategies of the last 25 years or so, which relied on efficient markets to drive those who run its largest institutions to work their will for everyone else’s benefit.
What we need now is a new debate over the terms of a new economic strategy. One place to begin is by limiting some of the risks taken by institutions that dominate critical markets, which the rest of us also depend on. It’s hard to do, because it’s very difficult to even measure and monitor those risks. It also means effectively limiting the profits available to the society’s richest companies, and how often does that happen?
A greater challenge will involve facing up to the way that the fast-evolving global economy has undermined our capacity to create jobs and deliver rising incomes for most people. It’s not about sending jobs to China. Rather, it’s about how hard it’s become for many companies, facing intense competition from tens of thousands of new foreign and domestic businesses created in globalization, to raise their prices when their cost go up. So as their health care and energy costs have marched up, they’ve cut other costs – starting with jobs and wages. And whenever this crisis and downturn truly end, the intense competitive pressures that indirectly eat into the American incomes will be as strong as ever.
The debate has to begin with the recognition that in this period at least, markets won’t cure these problems. If we truly want to restore steady wage gains, there will be no way to avoid serious government steps to slow future cost increases in health care and energy. A new strategy also has to acknowledge our only certain competitive edge in a global economy. In the country where the idea-based economy took hold first, our companies and workers still do better than most of their counterparts elsewhere in developing powerful new innovations, adopting them across the economy, and adapting them to their own particular circumstances. We have to generously fund both the seeds and the infrastructure of innovation. And we should help everyone develop the flexibility demanded to operate effectively in innovation-dense workplaces, by funding universal opportunities for people to upgrade their skills and education every year.