US economy: what the fuck?

What Kind of Economy? -- by James K. Galbraith / The Nation

In a debate over the Democratic future, no one should confuse the Hamilton Project with the Republican past. Robert Rubin and his associates have invited a broad dialogue on economic inequality and strategic investment, and on many specific policy questions--including education, health, taxes and wages--they will define the high-profile, wholly respectable neo-Clintonian position in the season ahead. There's nothing wrong with that.

But these advances come at a price, which will be exacted in two areas: the world trading system and domestic fiscal policy. Both of these are far more fundamental to the Hamilton mission than any particular social policy reform. Indeed, one purpose of the Hamilton Project, it seems clear, is to propose just enough creative social advances--such as wage insurance, better teacher pay and healthcare reform--so as to divert discussion from the bedrock commitments to free trade and a balanced budget.

Progressives shouldn't let this happen. And yet we have our own work to do: Our trade position is obsolete, and there is for now no clear progressive fiscal policy. We need to be talking trade and budgets, not simply because they are too important to bargain away, and not just to contest Rubin's worldview, but to build one of our own that is realistic, compelling and also serves larger purposes, including environmental survival and social justice.

On trade, the Hamiltonians favored the North American Free Trade Agreement, while most populists and progressives opposed it. This fight has been replayed endlessly, and it continues to color the arguments over the Central American Free Trade Agreement and the bilateral free-trade agreements now under negotiation. But as some NAFTA opponents, notably Jeff Faux, have recognized, it's time to get over it. Whether NAFTA created or cost jobs initially, the economies of Mexico and the United States are now about as integrated as they are going to get, and the effect is basically finished. As a result, Mexico's economy grew with ours in the late 1990s and went bust when ours did in 2001. Almost all discussion of outsourcing now focuses on China and India, two countries with whom we do not have, and will not get, free-trade agreements.

More broadly, the late 1990s showed two things about trade agreements. First, they don't prevent full employment in the United States: We went smartly to a full employment economy in 1998 and stayed there for three years. Second, they don't do much good either. Compared with the productivity gains engendered by full employment in the boom, those brought on by NAFTA in the mid-1990s were trivial if detectable at all.

So what's the debate these days really about? Why are the Hamilton Projectors so passionate about "free trade"? Perhaps the reason has something to do with the industries they come from. US finance, insurance and the "intellectual property" trades want "free-trade agreements" (and a successful conclusion of the Doha Round of World Trade Organization negotiations) because they want access to other markets and stiff enforcement of trademarks, copyrights and patents. In addition, agribusiness--another sector at the forefront of current trade talks--wants every wheat, corn, rice and cooking-oil consumer it can find.

Trade agreements pushing this agenda don't cost American jobs. The problem is that they are predatory. Thus a main effect of forcing open agricultural markets in Central America will be to displace small corn and bean farmers from the land, increasing migration: As food moves south, people move north. A main effect of the TRIPS regime--the international agreement on intellectual property rights--is that it has obliged poor countries to pay extortionate prices for medicines. A main effect of open financial markets is capital flight and tax avoidance. All of these are well worth opposing, without the crutch of a pretext, and a new agenda might start with this slogan: "Get the fraud out of free trade."

Trade with China is another matter, for here is a fast-growing country that benefits hugely from US trade. China thus poses the question of trade without posing a question of trade agreements. And China has many people very worried.

On China the Hamilton Project--otherwise resolutely against interventions--has harnessed widespread anxieties to its own objectives. The Hamiltonians endorse the idea that China is a challenge. It is a challenge, they say, to be dealt with not via tariffs or quotas but by a massive revaluation of the Chinese currency, the renminbi (RMB), for which liberal senators like Charles Schumer and economists like Tom Palley also forcefully call.

Would a big RMB revaluation solve America's China-trade "problem"? Well, it might hit China's exporters (and also, inevitably, its workers) hard. Multinationals might migrate to other low-wage countries; American importers might seek other sources of supply, in other corners of the Third World. But this much is sure: Not a single low-wage job would return to the United States. So, American consumers could be harmed, while American workers wouldn't be helped. One has to ask: What gives? Why is this an issue for the progressive agenda?

Who really benefits from the pressure that our Treasury Secretary from Goldman Sachs, Henry Paulson, has been putting on Beijing? Well, speculators have flooded Chinese property markets in the past few years, contributing to a massive bubble in Shanghai and elsewhere. (China's trillion-dollar asset reserves come largely from sterilization of those investments--a central bank maneuver to insure that dollars do not circulate in China--and not just from its trade surplus.) If Paulson succeeds, they clearly would make out nicely. It may be that some of those speculators live in New York. That may explain Paulson's call--and Schumer's support--for an RMB revaluation. But it's not a reason for the rest of us to jump on board.

The facts are clear: NAFTA is a done deal, and China is a success story we have to live with. Progressives need a trade narrative that moves past these two issues. Broadly, this means accepting manufactured imports and dropping the idea that we can control--or that it matters much--who assembles television sets or stitches shirts. Standards to guard against flagrant abuses such as child and prison labor are fine, but it's an illusion to think they will, or should, dent the flow of goods from China. A progressive trade agenda should focus, instead, on building stronger world markets for our exports, and in ways that do not trample on the needs and rights of poor people in poor countries. That should provide plenty of room for future fights with free-trade absolutists.

At home, we have better things to do. We should specifically focus on creating new jobs, in sectors (including high tech, education, healthcare and energy conservation) that meet national needs and build world markets for our goods. We should rebuild our cities and transport systems, protect our vulnerable Gulf Coast and otherwise get on with meeting the challenge of climate change. And that raises the second big problem of the Hamilton agenda, which is its insistence on balancing the budget.

Today, many Democrats are converts to balanced budgets and pay-as-you-go budget procedures, and many accept that when Democrats return to power, deficits must be cut before anything else is done. But the world has changed, and while this formula appeared to work for Bill Clinton, it probably won't work for Hillary if she gets that far. Clinton was able to preside over a largely private-sector boom--the information-technology bubble--that can't be repeated, in a time when we weren't yet aware of the wolves at our door. But, just as Alexander Hamilton proposed to build America with public works, today we require major public investment for the vast challenges we face. Of these, as Al Gore warns, the largest is to transform our patterns of energy use and defend against climate change.

If we fail here, then in a century or so some of our coastal cities and many others elsewhere will flood--as New Orleans did--suffering irreparable damage. Around the world, food supplies will fail and populations will move--massively, uncontrollably, miserably. If future generations mean anything, the benefits from preventing this are clear. The necessary scale is huge. The work must start soon. It makes sense to borrow to do this job, especially given the prevailing low long-term interest rates. If we insist on paying from current revenue, it won't happen. And that is what is at stake, just to begin with, in the argument over balancing the budget. There are other important issues, but this one is quite sufficient to make the point.

Thus, even if running budget deficits has important economic costs, we ought to pay them in order to meet our most pressing objectives, on climate change and other priorities. But in fact running moderate fiscal deficits has no discernible costs. In particular, the claim that current deficits are raising interest rates can't be backed up even by the best efforts of those who believe it. In a paper last year, I examined the detailed work on this topic of two leading Hamiltonian economists, Bill Gale and Peter Orszag, and showed that their own econometrics found no such effect. When I pointed this out, Gale and Orszag reacted with silence.

Deficit-fetishism also bolsters the perennial campaign to cut the Social Security system, now taken up by the alarmist David Walker, head of the Government Accountability Office, and by Ben Bernanke, chair of the Federal Reserve System. Here the Hamilton Project strategy document is extremely reticent--it barely mentions Social Security by name. But it is riddled with code words about the long-term "entitlement problem," which, it avers, can be solved only by a "bipartisan commission" acting on well-known options, behind closed doors. This is not reassuring.

In fact, Social Security is in better financial shape than ever, holding vast stocks of Treasury bonds on which interest can and will be paid. No economic or budget imperative requires that Social Security be cut, now or later. In private discussion Hamilton leaders let on that they understand this. But they are prepared, nevertheless, to include Social Security cuts--pension cuts for America's elderly, many of whom would otherwise be poor--in some sort of grand deficit bargain. Progressives must be absolutely categorical in rejecting any such deal.

Healthcare costs are a big problem. But they are a problem affecting both public and private healthcare, not Medicare and Medicaid alone. And it's highly unlikely that the problem of rising healthcare costs will extend to the point projected by Bernanke and Walker, who imply that healthcare will absorb one-third of the GDP within a generation--two or three times as much as in any other country. If that happens, as Dean Baker, co-director of the Center for Economic and Policy Research, has pointed out, we could cost-effectively contract out medical care to the Canadians and the French.

Is there anything really wrong with fiscal policy right now? Present deficits are small, and it's obvious from low long-term interest rates that financial markets do not take the exploding-deficit stories seriously. The greater risk is that a continued fall in home-building and prices could bring on recession, requiring a more active fiscal policy and bigger deficits than we have now. Sure, Congress should let the Bush tax cuts mostly expire, and if one wants to raise future tax rates just to make the long-term projections look better--well, fine. But that's a cosmetic gesture, with no current impact, and easily changed if need be by any later Congress. Our main task is to deliver on the real needs of the country. If we do that, fiscal transgressions will be forgiven. If we fail, fiscal probity will neither excuse nor save us.

Finally, progressives should turn their energies to a challenge that the Hamiltonians never discuss and seem determined to ignore, and that is to devise effective new rules for the global financial system. For the world is changing in ways that will not permit a return to the go-go Wild West of international finance of the 1990s, even if Robert Rubin and his colleagues do return to power in 2009.

The 1997 Asian crisis and the 1998 Russian crisis marked--it is now clear--the last days of an illusion: that unfettered global credit markets can govern themselves. Russia has since retreated into itself, Asia is developing a sophisticated substitute for the Asian Monetary Fund we denied them a decade ago and most of Latin America has rejected neoliberal globalization at the polls, while new structures of mutual assistance for development are gradually being built. The chaos of a financial system run by bankers alone is therefore gradually yielding to new systems of control.

We should welcome this development. We should oppose efforts to introduce new instabilities--which is basically the issue today between Wall Street and China. The challenge before us is not to restore the global dominance of American banks. We should not play junior partners in that game but instead should help plan for a smooth transition to something better--protecting as far as possible not symbols of power but the broad benefits of our standard of life.

As part of this, a progressive economics needs to break with the polite traditions of our subject in one other way. We cannot avert our eyes, as many economists habitually do, from the disaster of Bush's foreign policy. The calamity in Iraq is plainly causing the world to rethink how much it can rely on American leadership, and this has consequences already visible in the decline of the dollar. If there is a war with Iran, the rethinking will accelerate, and what we've seen so far could be only a harbinger of greater difficulties still to come.

Although a collapse of the dollar reserve system probably isn't imminent, this issue will not disappear, even if Bush's policies are decisively rejected in 2008. Left unattended, it could lead to a repeat of the 1970s, when progressive hopes were knee-capped by international financial instability, a declining dollar and externally inspired inflation.

This problem defies easy solutions, but we who are progressives, who are populists, who are concerned about the economic security of working Americans, of the country as a whole and of the world system, should be thinking about them. We should be working, with international partners, on blueprints for a new system combining mutual and collective security with economic stabilization. For only this can foster sustainable development worldwide, while at the same time permitting us to attend to social justice and the environment at home.

This is not a job that private banks want to turn over to us. It is therefore not going to be found on the agenda of the Hamilton Project. That is a powerful reason that it should be on ours.

(James K. Galbraith's Unbearable Cost: Bush, Greenspan and the Economics of Empire has just been published by Palgrave-MacMillan.)