Troubling fourth-quarter-2012 GDP data and unemployment numbers that are stubbornly high despite a decrease in labor force participation rates should have US policy-makers worried. There is always the danger that the Great Recession and its after-effects may be perceived as just another business cycle ( similar to others in the last few decades, just a bit more severe ) and not a sign of significant long-term shifts in the US economic landscape. The more policy-makers view the recent economic problems of the US as an isolated business cycle, the greater the danger that long-term shifts in the US economy, the global economy and the US-global economic linkages will be ignored in policies and short-term considerations will prevail.
The fact that the Fed has had to keep key interest rates at zero or near-zero for a long time and the fact that the Fed has resorted to several rounds of aggressive monetary easing ( in the process making control over possible future inflation difficult due to its purchase of risky MBSs ) is one sign that things are not normal. That the growth and unemployment numbers have remained unimpressive despite these unprecedented measures is an indication that things may go the way they did in Japan over the last two decades. The fact that the US has experienced the recent economic catastrophes and the recent slowdown in its economy despite a decade of low-tax policies holds several lessons. First, low-tax policies do not correlate with high growth rates or high investment rates. Secondly, low-tax policies, even when followed over long periods of time, do not prevent recessions and a deepening of low-tax policies does not necessarily contribute to economic recovery during or after a recession. Also, there is only so much that fiscal policy can do in the wake of a crisis that has as its trigger excessive over-investment in some sector of the economy. Once again, the fact that low-tax policies have not led to impressive economic performance and have not been able to prevent dramatic collapse in specific sectors and in the overall economy and have not been able to bring about significant recovery is a sign that malaises similar to Japan's are affecting the US economy and that there has been a shift in the economic realities.
While the Great Recession and its effects do not look as ugly as the Great Depression, this should be no cause for complacency among US policy makers. But the reality of the policy-making framework and the way the democratic process of the US goes about its task of reaching policy decisions should be cause for great concern. Tax-policy deals that lead to miniscule tax revenue increases compared to the scale of the fiscal deficit and the scale of the long-term debt problem is one example where the policy-making framework has failed the American people. An excess of political noise and a paucity of hard achievements does not inspire confidence in the ability of the system to be forthright with US citizens about the scales of the challenges, the hardships that may lie ahead and the adverse effects of elitist myths ( like anti-tax myths ) on the framing and execution of unbiased economic policies.
The fact that the economic profession has been marked by deep theoretical divisions in several areas like monetary policy and fiscal policy has meant that it has not been able to provide a whole lot of apolitical or ideologically unbiased inputs into the economic policy-making process. Moreover, questions like public debt have received less attention than the growth aspects of monetary and fiscal policy. However, public debt and the sustainability of public finances is a major area of concern for the US right now. And the public debt will become more of a problem in the next ten years. How much of the burden of fixing deficits should fall on the taxation side and how much of the burden should fall on the spending side ? Not only does the economic profession not have clear answers to these questions, but whatever standard methods of analysis have been developed over the years find themselves somewhat flummoxed in the face of these questions. This creates conditions where ideological considerations and political opportunism have a much greater influence on economic policy than is healthy for the economic system and its ability to provide for the people. The IMF, which usually has a large number of US-trained economists, has been in the business of advising and specifying solutions to countries around the world during economic crises, some of which happen to be debt crises. However, the IMF's usual role has been to respond after a crisis has begun. The ethos of trying to identify possible scenarios of debt crises, of quantifying the risks, of using projections to predict the approximate times of crises in the absence of major policy changes and of making serious efforts to fix the deficit-debt-short term growth-long term growth-government spending-government revenue framework in order to avoid major debt crises has been lacking at the national level in many important economies and the US is no exception. In fact, the US approach to the public debt problem during the past decade has been one of complacency and indecisiveness and continues to be so.
When the economic output plunges or stagnates, public finances become more severely strained. This aspect has tended to have a bigger impact on the economic health and economic policies of European countries like Greece and Spain, whose economies are smaller compared to the US. However, one has to take cognizance of this fact even for big economies like the US. Since democratic politics creates conditions where short-term considerations of all kinds tend to prevail, it is difficult for economic policy to be immune to these political dynamics. No wonder then, that there is a tendency to think that a resumption of higher growth should take precedence over everything else. While the quick resumption of high growth trajectories has its benefits, public debt is affected by factors that go beyond just growth and that definitely go beyond just short-term economic growth. For example, the debt build-up of the US had been happening through the first decade of the twenty-first century even before anything catastrophic like the Great Recession happened. The US democratic system, its political system and that part of the economics profession that has been involved closely with US economic policy-making have not yet properly come to terms with the public debt problem and they have not been able to reach the desired level of objectivity for judging how taxation and spending affect the fiscal deficit, the public debt, short-term growth and the long-term sustainability of GDP growth and public finances. Economic stagnation or economic slowdown merely makes this a harder challenge. But it still is a hard challenge even when the economy is doing well and will likely be even more of a hard challenge in the future, whether the GDP numbers are bad or whether they are good.
by C. Jayant Praharaj ( send comments to cjpraharaj.blog@gmail.com )
The Global Analyst ( Commentary about economic, environmental, political and other topics )
