Campaign 2012: Twelve Independent Ideas for Improving American Public Policy

by Benjamin Wittes (Editor)

Overview

"Campaign 2012: Twelve Independent Ideas for Improving American Public Policy is an indispensable guide to the questions facing White House hopefuls in 2012, as well as the challenges awaiting the winner. It presents authoritative analyses of a dozen key policy issues currently testing the nation:

-domestic economic growth

-America's role in the world

-the budget deficit

-China relations

-health care

-Afghanistan and Pakistan

-federalism

-Iran

-reforming government institutions

-the Middle East

-climate change

-terrorism

This is truly Brookings at its best—independent expert analysis, presented in an accessible manner and offering viable solutions.

"

Product Details

ISBN-13:	9780815721987
Publisher:	Rowman & Littlefield Publishers, Inc.
Publication date:	05/17/2012
Edition description:	New Edition
Pages:	248
Product dimensions:	5.90(w) x 8.90(h) x 0.80(d)

About the Author

"Benjamin Wittes is a senior fellow in Governance Studies at the Brookings Institution, where he directs the Campaign 2012 Project. His previous books include Law and the Long War (Penguin) and Detention and Denial (Brookings)."

Read an Excerpt

CAMPAIGN 2012

Twelve Independent Ideas for Improving American Public Policy

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BROOKINGS INSTITUTION PRESS

Copyright © 2012 THE BROOKINGS INSTITUTION
All right reserved.
ISBN: 978-0-8157-2198-7

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Chapter One

MARTIN NEIL BAILY

Restoring Economic Growth: The Next President Must Nurse a Fragile Recovery

James Carville famously remarked of the 1992 election, "It's the economy stupid!" and the same will be true of the 2012 election. When President Barack Obama came into office, he embraced the challenge of turning the economy around. The policies he followed to stabilize the banks and provide stimulus to a tumbling economy were the correct ones and succeeded in stopping the collapse. Unfortunately, Obama and his economic team were overoptimistic about how fast a full recovery could be achieved. An extended period of slow growth was inevitable, given the severity of the crisis and recession. There should have been a more single-minded focus on the recovery, and the administration's ambitious policy agenda in other areas should have been scaled back.

Republicans are blaming Obama for the continued economic weakness, which they say is caused by excessive government intervention. It seems delusional to blame the financial crisis and resulting recession on too much regulation, but Obama's policy overreach has made it easier to paint him as an advocate of big government. His reelection will depend heavily on whether the economic recovery strengthens or weakens in 2012.

The immediate problem facing the economy is weak demand. Recovery is under way, but it continues to be slow, and it could falter in 2012. It will need to be nurtured both in the remainder of this administration and in the next presidential term. Given the budget crisis, there are limits to what more can be done with federal spending, but I lay out here eight important steps to restore growth:

—Continue the stimulus for workers' incomes.

—Maintain assistance for housing.

—Provide continued aid to the states.

—Control the trade deficit.

—Help Europe address its debt crisis.

—Set a framework for a balanced budget.

—Bring in private capital and maintain funds for infrastructure projects.

—Embrace the trends in developing technology, skills, and competition in education.

The Obama Record

The financial crisis started in 2007 and evolved into a full-blown recession by 2008, with the rate of job decline hitting a high point of over 700,000 private sector jobs lost a month between November 2008 and the late spring of 2009. Private sector payroll employment fell 8.8 million from its peak to its trough. The financial crisis and severe recession were deeply damaging, and no president had the power to turn around the economy quickly. Although the U.S. economy had bounced back pretty quickly from severe recessions in 1975 and 1982, this recession was very different. The job loss was far more severe, and the bursting of the housing bubble left a legacy of trillions of dollars of lost wealth, underwater mortgages, weakened banks, slow-growing wage incomes, and collapsing residential construction.

The fiscal policy of the Bush administration tied Obama's hands in dealing with the recession. Although George W. Bush had inherited a fiscal 2000 budget surplus, he ran large budget deficits from fiscal 2002 to 2008, which in his last year amounted to 3.2 percent of the gross domestic product. These deficits limited the size and duration of the stimulus policies available to overcome the collapse of private demand.

In the face of those limitations, the Obama economic team and the Federal Reserve deserve great credit for rescuing the financial sector and pushing through a substantial fiscal stimulus. Credit also goes to the Paulson Treasury, which started the bank rescue program. Neither the bank rescue nor the stimulus package was pretty; in fact both were pretty ugly. But they did what they had to in stopping financial sector collapse and contributing to a sharp economic turnaround, which saw GDP go from a nearly 9 percent decline in the fourth quarter of 2008 to well over 3 percent growth by the fourth quarter of 2009 and the first half of 2010. The bank stress tests were particularly important in establishing the amount of capital needed and making sure it was available. Both the broad economy and status of lower-income Americans would have been much worse had there been no financial rescue. It took courage and judgment to rescue the banks and stimulate the economy.

Given the severity of the economic crisis, Obama should have told Americans when he came into office that it would take several years for a solid recovery to take hold, that the recession and the responses to it would trigger very large budget deficits, and that many of his signature programs would have to be postponed until recovery was certain. Budget deficits have indeed become huge, hitting $1.4 trillion in 2009, $1.3 trillion in 2010, and $1.3 trillion in 2011. The amount of federal debt held by the public rose from $5.04 trillion in 2007 to $10.16 trillion in 2011, equal to 72 percent of GDP. With the interest rate on ten-year U.S. Treasury securities hovering around 2 percent, there is no evidence yet that global financial markets are pricing in a significant risk of Treasury default. Still, the path of budget deficits is not sustainable for much longer and fiscal consolidation will be needed.

In response, Obama established the Bowles-Simpson Commission to draw up proposals for achieving long-run fiscal sustainability. However, he largely ignored its findings and did not embrace an alternative proposal or come up with his own plan until very late in the day. The explosion of the debt and deficit has contributed to the loss of voter confidence in the administration. The next president will need a solid plan to eliminate the budget deficit, not right now, but over the next ten to fifteen years.

The Republican Response

The Paulson Treasury Department in the Bush administration is credited with initiating the Troubled Asset Relief Program (TARP) and with realizing that massive federal intervention was needed to stop the financial collapse. When the financial crisis and subsequent recession revealed the problems of letting markets self-regulate, Paulson favored a more pragmatic and less ideological policy approach than was evident earlier in the Bush administration.

In the first two years of the Obama administration, with some moderate Republicans willing to be bipartisan, it looked as if both parties could agree to a financial reform bill. A bipartisan bill would have been much easier for voters to support. In the end, however, the Republican leadership decided it was more important or more expedient to oppose Obama than to work together to create a better and much-needed program of financial sector reform. So the Republicans pulled out of negotiations and voted against the reform bill of 2010 sponsored by Democrats Christopher Dodd and Barney Frank.

Although Republicans have expressed concern about the enormous federal deficits, a concern I share, their commitment to lower deficits is undermined by their refusal to consider any substantial revenue-raising options. Fully 238 U.S. House members, 41 senators, and all the GOP presidential candidates except one have signed Grover Norquist's no-increases-in-taxes pledge, thereby declaring their unwillingness to deal realistically with the long-run deficit problem. Even with the best possible Medicare/Medicaid and Social Security reforms acceptable to American voters, the biggest acceptable cuts in defense spending, and sharp cuts in the rest of discretionary spending, additional revenues would still be needed to tackle the deficit problem.

The Republican frontrunner Mitt Romney and much of his economic program blame Obama for the bad economy, attributing it to a surge in regulation and the sharp increase in federal spending. Ironically, Romney's plan was authored by Glenn Hubbard, a talented economist but also an important architect of the George W. Bush administration policies that contributed to, perhaps even caused, the crisis and recession.

In view of his record as a moderate governor of Massachusetts, Romney could become a conservative but sensible president. His successful business background shows he has experience in running an organization. In order to gain the nomination, he has put forward an economic plan that involves substantial new tax cuts, getting rid of the Dodd-Frank financial regulations, ending federal support for expanded health care, making large but largely unspecified cuts in federal spending, and pushing for a balanced budget amendment. One can hope that he would not be a prisoner of his own rhetoric if he becomes president and that his economic advisers learned something from the Bush administration's mistakes.

Policies to Revive Growth

The economy has been trapped in a vicious cycle of slow-growing companies' sales and limited hiring. The resulting lousy labor market means slow growth in household income. That in turn keeps household debts high, the value of houses depressed, and consumer spending weak, perpetuating the cycle of weak demand. The excess housing and high consumer debt are two anchors weighing down the recovery and making it harder to break the vicious cycle.

Economist Tyler Cowan attributes the weakness in jobs and growth to a slowdown in the pace of technological advance, whereas Erik Brynjolffson believes the opposite is true, that technological change is proceeding so rapidly that it is making work obsolete and increasing structural unemployment. Neither of these views fully accounts for the nation's current problem. Productivity growth in the nonfarm business sector of the U.S. economy has been in the range of 2 to 2.5 percent for the past twenty years, so there is no sign of big swings on the supply side of the equation. Furthermore, although population and labor growth have slowed, these are not the causes of high unemployment.

Technology and innovation, broadly understood, are having and will have a massive influence on long-term growth and the nature of work. As much as it is important for public policy to stimulate science and technology, demand is the big issue right now and the focus of this chapter.

Despite the weak job market and debt burdens, consumers have started spending again, with a moderate rate of 2.3 percent growth over the ten quarters ending in the third quarter of 2011. Overall growth in the first half of 2011 was very weak, but second-half growth was a solid if not exciting 2.4 percent, so the key question is whether that pace will flag in 2012 or pick up. To keep up the pace, the current and the next president—be that Obama or a Republican—should take the eight key steps outlined in the following paragraphs.

Continue the Stimulus for Workers' Incomes

As Figure 1-1 shows, the Great Recession has caused a large drop in median real income across workers ranging in age from twenty-five to sixty-five. They represent the households that depend upon wages and salaries and have been badly hurt. The top priority for economic stimulus is to get additional funds to these low-and moderate-income families.

The struggles between Congress and President Obama have made it hard to enact even the modest amount of fiscal stimulus that is possible in the deficit environment. However, the ten-month extension of the payroll tax cut Obama signed into law on February 22 guarantees workers $1,000 of additional take-home pay for the year, and the legislation also extends unemployment benefits.

If growth remains very weak through 2012, it will be necessary to extend that tax cut into 2013, and if there is a double-dip recession in 2012, the next president will have to consider additional income support measures. One approach would be to give all taxpayers a $1,000 rebate (adjusted for singles or couples and phased out for high-income filers). Such a measure would carry some danger of triggering instability in financial markets, but a prolonged double-dip recession would add to the deficit as well, so the risk would be worth taking.

Maintain Assistance to Housing

If there were a good way to turn the housing market around, that would make a vast difference to the speed and robustness of the current recovery. Various measures, some initiated in the Bush administration and some under Obama, have been tried to make it easier for families to refinance at lower interest rates. Their effect has been modest, however, and housing is likely to remain weak in 2012, although the situation is gradually improving.

There are three main reasons why it is so hard to solve the housing problem:

—Nationwide, many mortgages are underwater—currently to the tune of $700 billion. Any serious effort to write down mortgage debt with government funds would be very expensive.

—The underwater mortgages are concentrated in a few states. California has 26.8 percent of such debt, and adding only Florida and Arizona pushes the total to nearly 48 percent. This means that any large-scale assistance would involve a big transfer to those few states and hence would be difficult politically.

—Addressing the underwater mortgage problem would help but would not necessarily revive home building or household spending. The big pool of home equity waiting to be tapped has gone, and the magic attraction of homeownership has been lost.

As my colleagues at Brookings Karen Dynan and Ted Gayer have pointed out in extensive analyses available online, it remains important to maintain assistance to the housing market so that it can continue to heal.

Provide Continued Aid to the States

Declines in state and local spending are contributing to weak demand and forcing cutbacks in education spending, road maintenance, and police, fire, and other social services. States that allowed their budgets to grow too rapidly in the boom years need to learn the lessons of sound fiscal budgeting. In particular, many failed to make adequate provision for retirement benefits promised to state workers and are now having to change their accounting and scale back the generosity of those benefits. But a time of fragile economic recovery is not a time to press for punitive cuts in state budgets. Federal funding and guarantees could prevent state and local government spending from becoming a further drag on overall economic recovery.

Control the Trade Deficit

Since the 1980s the U.S. economy has run large trade deficits driven largely by international capital flows and the resulting structure of exchange rates. In part, the United States has been its own worst enemy, spending more than it produces and borrowing overseas to pay for budget deficits and excess housing. But foreign countries bear part of the blame too, being content to accumulate U.S. dollar assets in return for keeping their exchange rates down and their exports high. Countries such as China, Germany, and the-oil producing states that run large chronic trade surpluses need to expand domestic demand and move toward balanced trade.

Before the crisis, the U.S. trade deficit was running at about 6 percent of GDP. With the decline in U.S. demand, imports fell and the deficit dropped to about 2 percent of GDP. If the deficit moves up to 6 percent again, this will put a substantial drag on U.S. growth. The president elected in 2012 should take three important steps to avoid this problem:

—Work with the International Monetary Fund (IMF) to encourage greater exchange rate flexibility globally, especially in the Asian economies. Some form of sanctions may be necessary for countries that manipulate their exchange rates and run chronic multilateral current account surpluses. The Palais-Royal Initiative of December 2010 made suggestions for strengthening IMF oversight, but more needs to be done in this area.

—China, in particular, needs to let its exchange rate appreciate. Public pressure or trade sanctions on China would be counterproductive, but the United States should work with its allies to make it clear that China must maintain external balance. China has run large trade and current account surpluses and accumulated an excessive level of reserves ($3.2 trillion at the end of June 2011, up from under $1 trillion in 2006). China's current account surplus has been falling in recent quarters, and the Chinese should adjust their currency to make sure it stays that way.

—Balancing the federal budget over the longer term would greatly reduce the need for foreign financing and help avoid an overvalued dollar.

Help Europe Address Its Debt Crisis

A worsening of the crisis in Europe, with cascading financial failures, would almost certainly trigger a double-dip recession in the United States. A collapse in Europe is the biggest danger to a continued U.S. recovery in 2012 and beyond. It is in America's interest that the European financial crisis be resolved or at least contained. For political reasons, however, the current administration wants to make sure that U.S. contributions to the IMF are not used to "bail out" Europe. This is a serious mistake, and the restrictions on the use of U.S. funds should be eliminated. U.S. taxpayers would almost certainly be repaid if any U.S. funds were used. Moreover, the policy stance of the United States is discouraging other countries, such as those in Asia, from helping Europe.

(Continues...)

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