From the April 16th keynote presentation at the International Economic Forum of the Americas in Palm Beach, Florida.
By Mickey D. Levy
Emerging nations truly have emerged—in the last handful of years, emerging markets such as China, India, Brazil, and other Latin American nations as well as Russia have generated well over half of all global growth, and their total share of global output has increased significantly, with large and vibrant economies. Since before the financial crisis and deep recession, these nations have been growing three to four times faster than the richer advanced nations. Their sustained rapid growth has literally lifted hundreds of millions of people out of poverty—largely through adopting a managed capitalism and entrepreneurship and emphasizing exports—and their middle classes are growing rapidly. They contribute significantly to world trade, not just exporting goods to the U.S., but expanding the amount of U.S. goods and services imported.
How do you compete in this rapidly evolving world? Consider different levels. For governments, competing means establishing sound policies, including healthy and sustainable finances and open channels of international trade that are conducive to innovation and expansion, healthy long-run growth, and permanent job creation. For businesses, it means implementing technological advances and forward-looking strategies and improving internal processes that make you the most efficient low cost producer with a keen understanding of global trends and cutting-edge distribution networks. For individuals, it means constantly building human capital and maintaining skills during this period of rapid innovation, and using those skills to your advantage—that’s the key to creating demand for your services and getting ahead.
Here’s my current scorecard. The U.S. has the advantage of being the world’s biggest economy and is also the leader in innovations and technological advances in a wide array of industries, supported by its entrepreneurship and capital system. But it is damaging itself and undercutting its future through unsound economic policies and the failure of its government to address the largest critical issues of this generation: fiscal policy, health care, energy, and education. These are not new issues. In the near term, the U.S. economy will experience improved economic growth and performance, but reforms are desperately needed to maintain competitiveness.
The U.S. economic expansion, although slow to recover, is starting to gain traction. Consumption is growing moderately and housing activity has turned the corner, despite the distressed mortgage mess. Exports continue to grow, despite the financial crisis and recession in Europe. Businesses are responding to the pickup in product demand by hiring more. However, business investment spending remains tentative. I anticipate stronger growth for the rest of 2012, but the unemployment rate will remain high.
Europe’s current financial crisis is the cumulative consequence of failed fiscal, labor and regulatory, and banking policies. Many European nations have been living beyond their means for decades, and the adjustments and reforms they must undertake to improve economic performance and restore competitiveness and fiscal soundness. Thosewill involve lower real wages and lower standards of living and will be painful. While Germany and other northern European nations are enjoying healthy economic performance, having benefited from earlier economic and fiscal reforms, many European nations are in recession. This exacerbates the financial problems faced by their governments and banks, and increases the difficulty of implementing needed reforms. Global financial markets will continue to test the resolve of European policymakers.
The story for each emerging nation is unique, but some, like China, that have grown largely through policies promoting exports must modernize their financial systems, improve governance and implement policies that shift reliance from exports to domestic demand. For others, education and skills are critical for addressing performance and income inequalities. This is very important to global economic performance but will take time.
For most key nations and regions, there are large imbalances both internally and externally.
The U.S. has been running persistently large trade and current account deficits—it imports much more than it exports and has insufficient national saving relative to investment, so it relies on foreign capital inflows to fill the gap. Japan has a large current account surplus, but its demographics (declining population, even faster decline in labor force, and failed immigration policy) and fiscal and other economic policies paint a bleak picture for future potential growth. China also runs a large trade surplus and has accumulated over $3 trillion in hard currency reserves, about one-third of which is loaned to the highly indebted U.S. government.
Europe is mixed. Some nations, like Germany and Austria, that have enhanced their international competitiveness through productivity and constraints on unit labor costs of production, enjoy trade and current account surpluses, while most southern European nations that have high unit labor costs and lack competitiveness have large deficits.
Beneath each internal and external imbalance are skewed or misguided government policies, varying degrees of private sector competitiveness—and a challenge. How do you promote more balanced global growth—with an eye toward improving every nation’s long-run economic performance?
Let’s begin with the U.S. For several decades, through 2007, the U.S. consumed too much and households borrowed too much. Debt rose to unsustainable levels, and consumption of goods and services, and investment in residential real estate rose way too high relative to GDP, while business fixed investment net of depreciation declined. A lot of this economic and financial behavior was fueled by government policies. The government’s long-run deficit gap is huge—measured in the tens of trillions of dollars—and the current composition of government spending is skewed heavily toward supporting current income and consumption. Government spending and tax policies deter investment. The government’s housing policies—still based on the flawed government sponsored entities—Fannie, Freddie—encourage debt leverage and poor credit quality mortgages. So it’s not just the magnitude of the U.S. government’s budget gap, but how specific spending and taxing programs are allocating resources and incentivizing household and business behavior that is the foundation for the U.S.’s imbalances. U.S. policymakers are too quick to blame others—like China—for U.S. problems. Instead, they should look inward: U.S. policies are largely to blame.
Clearly, the U.S. must consume less and save, produce and export more. Since the financial crisis, that has begun to unfold, U.S. households have slowed spending, saved a bit more, and deleveraged. U.S. businesses have generated significant productivity gains and have reduced their unit labor costs relative to most overseas nations, supporting export growth. Technological innovations are creating new products and enhancing commerce at an exciting pace. But the government’s policies are the biggest obstacle to healthy, sustained balanced growth and finances. The U.S. current account imbalance has narrowed, but primarily because the government’s dissaving (budget deficits) is partially offset by record-breaking business saving. We want just the opposite—for businesses to spend more and invest, and government to reduce its deficit!
The inability to address the nation’s long-run fiscal imbalance—which by allocating more and more national resources often in very inefficient ways toward debt service, pensions, and health care, reduces productive capacity—reflects the appalling lack of leadership in Washington. Economic rationale and what’s right for the nation is subjugated to short-sighted politics and selfish opportunism.
Make no mistake—even though the unsustainable fiscal debt and wrong-headed economic policies are not pushing up inflation or interest rates,they are eroding the U.S.’s ability to compete, harming businesses, and are dampening our long-run potential. That the Federal Reserve is pursuing unprecedented monetary easing in an effort to stimulate demand when fiscal and regulatory policies would more effectively address current problems—and elevating the Fed to the largest holder of U.S. Treasuries, is unhealthy, unsustainable, and very risky.
The political stalemate on energy policy is also very costly. Education reform shouldn’t be a political issue, but it is. Meanwhile, while educational attainment in the U.S. improves only modestly—over half of all working age citizens have a high school education or less—educational attainment is zooming ahead in many emerging nations. Amid the global demand for skills and knowledge-based workers, this is also eroding the U.S.’s ability to compete, and a primary source of undesired income and wage differentials. Currently, the unemployment rate for those with at least a college degree is near 4 percent, while the unemployment rate for those with a high school education or less is over 12 percent. It is a sad commentary that for several decades, public teachers unions have been the largest obstacle to education reform.
European problems are far more complex than the U.S.’s. Whereas most European nations are far ahead of the U.S. in reforming government fiscal policies, most are far behind in recapitalizing banks, implementing labor reforms, and forcing declining real wages in order to restore global competitiveness. Their labor laws and regulations virtually lock in slow growth. The financial situation facing European governments and banks is severe, and recessionary conditions make achieving necessary reforms very difficult.
Overall, European economic growth and performance will languish during a lengthy adjustment period. However, even in this very difficult environment, there will be excellent investment and export-related opportunities in European businesses and sectors that push ahead with reforms and productivity.
China has pursued an export-oriented economic policy, through government policies that have maintained an artificially low currency, and invested very heavily in production and export-related projects. It allows for a “managed” style of free enterprise and capitalism. This has produced sustained, rapid economic expansion and a dramatic increase in standards of living. But at the same time, China’s financial system represses its citizens through backward financial markets with limited investment opportunities and its dominant and self-serving state-owned banks. Facing limited investment opportunities, including an “unreliable” stock market, increased Chinese wealth has been funneled into real estate, generating a housing boom.
China has faced an inflation problem, and its robust economic growth and labor demand have generated rapid increases in wages. While China’s unit labor costs remain well below global standards, as they rise, China’s potential growth will slow. My hunch is China’s leaders will be sufficiently flexible and manage gradually slower growth and avoid a hard landing. But in the context of today’s conference, China must modernize and liberalize its financial system, and alter government policies to provide a broader social safety net and encourage consumption. A rebalancing of China’s economic growth would sustain China’s outstanding economic performance, contribute to improved global balances, and enhance U.S. export opportunities.
It’s not a zero-sum world that imposes a loser for every winner. Nevertheless, we will be competing in an expanding and highly competitive world. With the exception of Europe, economic outlooks are improving, particularly for the U.S.
But risks abound, and economic policies matter a lot, and here, I am sad to admit the U.S. policies are distinctly harmful. We must get beyond the rancorous politics and short-termism. To end on a positive note, the U.S.’s entrepreneurship, innovations, technological advances, and capitalism put the U.S. in such a position of strength, my urge and hope is that we can address our fiscal and economic policies with foresight and fairness in a way that will allow strong growth and healthy increases in standards of living in the future.
Mickey D. Levy is the chief economist for Bank of America.
(photo courtesy of shutterstock)