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How Can the Economy Recover?

Still, in his forecast for Capitalism 4.0, Kaletsky writes:

The most distinctive feature of capitalism’s next era will be a recognition that governments and markets can both be wrong and that sometimes their errors can be near-fatal.

His recommendations often make sense. He argues that the Federal Reserve must broaden its objectives beyond such goals as managing inflation, and include support for employment, credit growth, and remedies for trade imbalances. He believes higher capital requirements are now needed for all financial institutions. He would like to see the US adopt an energy tax to reduce its oil dependency.

These reforms, however, will not deal with the rapidly growing levels of income inequality in the US or its stagnating wages. They offer nothing to replace as sources of growth our currently rising debt levels and financial speculation. Kaletsky reiterates the truism that a strong financial sector is essential to growth, adding neither a fresh defense of it nor a serious proposal to limit its size and power, at a time when it can clearly be seen to have done much damage.

Refreshingly, he recognizes that the West’s economies should be allowed to have budget deficits of up to 4 percent of GDP without the strain alarmists warn of. (Some call for no future deficits at all.) But then, along with so many others, he urges the US and other Western nations to cut back on public pensions and health care programs. In the long run, there is little doubt that rapidly rising health care expenditures are America’s most pressing financial problem. But reforming Medicare and Medicaid is not the answer; large-scale changes in the entire health care system will be needed, as Harvard’s Arnold Relman has argued in these pages.2 Rising health care costs are driving Medicare and Medicaid benefits to unsustainable levels. Acknowledging this, Kaletsky offers no serious remedies.

After decades of stagnating wages, lost health care coverage, damaged retirement programs caused by market crashes in the 1990s and 2000s, poor-quality education for lower-income families, and rapidly rising costs of college, most of America’s influential policymakers, including several official and well-financed private deficit commissions, now want to cut back Social Security and health care benefits without proposing any serious new employment programs to help a nation in which one of six who are willing to work cannot find a full-time job.

A prominent strand of thinking in the US holds that cutting social programs and limiting aid to workers are exactly what will revitalize the nation’s economy by demanding that people be responsible for themselves. In sum, markets should be as free of government interference as possible, and must become the efficient distributors of social goods. In Seeds of Destruction, Glenn Hubbard, George W. Bush’s former chief economist, and his coauthor, the economist Peter Navarro, write that such economic policies are the only way back from the edge of the precipice:

The difficult truth that must be told is that America is close to a destructive tipping point. We must change how we conduct our politics and economics and thereby rebuild and rebalance our economy, or we will inevitably go the way of all once-great nations and suffer an irreversible decline.

Like Kaletsky, however, their proposed reforms do not match their stated fears. Hubbard has long been opposed to deficit spending on conventional conservative grounds. It will, he argues, crowd out private investment and prevent markets from allocating productive capital to where it will be spent best. But the authors do not acknowledge that when the US economy is operating well below capacity, there is little private spending that the government could crowd out. It is simply not a concern. Nevertheless, to meet the modest future Social Security deficits, they would cut outlays by raising the retirement age and changing the way benefits are calculated.

Hubbard and Navarro accurately estimate the future deficits of Medicare and Medicaid care as largely a consequence of rising health care costs, not the aging population. In general, health care costs are growing 2 to 3 percent faster a year than GDP per capita in the US, and the costs of Medicare and Medicaid to the federal government are driven up at the same rate.

To reduce the growth of health care costs, Hubbard and Navarro would no longer allow corporations to exclude the cost of health insurance from the taxes they pay. They argue that businesses will then provide less generous and wasteful plans to their executives and workers. If this turns out to be politically impracticable, they would allow individuals to deduct their medical costs from taxes. Presumably, they will then pay more of the bill directly rather than buy expensive insurance. The objective is to force those who use medical services to pay more of the costs. In other words, they want to introduce free-market forces into health care. But few would agree that this would adequately reduce rising health care costs. They would also impose a cap on the growth of Medicare and Medicaid payments, even if health care costs keep rising rapidly, leaving recipients with reduced coverage.

Perhaps their chief goal is to reduce progressive income taxes, which they believe undermine incentives to work and invest. Ideally, they would replace much of the income tax with a value-added tax (VAT)—basically, a national sales tax. Although it is regressive in the sense that it takes more from a poor person’s income than it does from a rich person’s. They argue that it will force America to consume less. They would also do away with taxes on capital gains and interest to encourage more investment and more savings.

Hubbard and Navarro generally avoid discussions of the costs to individuals of their reforms. Basically, they argue single-mindedly that lower taxes are the key to future jobs. In the end, they offer faith but few hard facts. Such a view is disturbingly familiar by now. It is Kaletsky’s Capitalism 3.0—the markets will make everything right. The authors disregard the fact that the philosophy they espouse has more or less been dominant since Ronald Reagan’s presidency. Progressive income tax rates have been flattened. Markets have been largely freed of regulation of product safety and prices. Antitrust and labor laws are hardly enforced any longer. And of course regulation of the financial industry was to a large degree abandoned. Without their improving the economic situation of most Americans, markets are much freer than they were during the rapid growth era of the 1950s and 1960s. In fact, the economy surged after Bill Clinton’s tax increase in 1993.

In a modest tribute to pragmatism over dogmatism, however, Hubbard and Navarro favor new regulations in finance. In particular, they want to increase the amount of the down payment required to obtain a mortgage. They would continue to impose capital requirements on banks, if more flexible ones. They would require that financial derivatives be traded through clearinghouses that would monitor transactions. They do not admit to any contradiction between their support of such regulations and their criticism of government and faith in free markets. In another political compromise, they would propose a “progressive” VAT, with credits for lower-income people. Some more liberal economists also support such a program.

But Hubbard and Navarro say little or nothing about green technologies, poor educational quality, decaying transportation infrastructure, or even stagnant wages. To do so would invite discussion of direct government investment and more incentives. They blame the loss of manufacturing in America, and the good jobs that come with it, essentially on the trade deficit with China, which they would rectify by demanding that all nations abide by international rules of free trade; they also want to prohibit manipulation of currencies. Apparently, America should simply insist that free trade be practiced around the world; but the authors should know by now that this proposal will be resisted by many countries.

We can get some idea of what Hubbard and Navarro’s free-market ideas will cost typical Americans because their central principles are the core of a new program, “Roadmap for America’s Future,” proposed with great fanfare early this year by Paul Ryan, the Republican congressman from Wisconsin who will presumably chair the House Budget Committee in the new Congress. It is a plan to balance the budget and reform the tax system, Social Security, and health care all in one.

The Washington Center on Budget and Policy Priorities summarizes Ryan’s plan quite accurately:

It provides the largest tax cuts in history for the wealthy, raises taxes on the middle class, ends guaranteed Medicare benefits, erodes health care coverage, partially privatizes Social Security, and makes deep cuts in guaranteed Social Security benefits.

Ryan of course claims that he will balance the budget with his spending cuts and new tax reforms. But the Tax Policy Center, a joint effort of the Brookings Institution and the Urban Institute, says that if it is implemented, his plan would raise far less revenue than he claims. The budget would not be balanced.

In a new book about the causes of the financial crisis of 2007 and 2008, Robert Reich, the liberal former labor secretary under President Clinton, also believes that the US is at a critical point. But he recognizes that a return to the pre-2007 economy is tantamount to failure. Reich proposes aggressive policies to change America’s course by using rather than limiting government.

For Reich, the issue is clear—it is the lack of jobs and more particularly the low wages paid to many who have jobs. “What’s broken,” writes Reich, “is the basic bargain linking pay to production. The solution is to remake the bargain.” If Americans don’t earn more, Reich says, there will be persistently insufficient demand for the goods and services the US makes. Reich believes that income inequality and relatively stagnant wages for thirty years accounted for the volume of subprime and other borrowing that directly led to the credit crisis. He wants simply to give money back to lower-income workers by taking it from higher-income workers. The full-time worker earning $40,000 a year would get a supplemental check from the government for $5,000; the worker earning only $22,000 a year would get a $15,000 check. Reich would also cut the income tax rate for those earning up to $160,000 a year.

To pay for what he estimates would be more than $660 billion in such wage supplements, Reich would raise taxes on those earning above $160,000. Those earning more than $410,000 a year, for example, would pay a rate of 55 percent in taxes, an increase of 20 percentage points. He also favors a substantial tax on carbon dioxide to raise revenues, reduce pollution levels, and support America’s energy independence. Together the two taxes, he says, will more than pay for the income transfer to poorer workers. Income inequality, which he believes is the nation’s major economic problem—above all because it acts as a brake on purchasing power—would be sharply reduced.

  1. 2

    See “The Health Reform We Need and Are Not Getting” and “Health Care: The Disquieting Truth,” T he New York Review, July 2, 2009, and September 30, 2010. 

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