An Economic Strategy for Mr. Obama
Post on the Wall Street Journal's Real Time Economics
© Wall Street Journal
The Bush administration has been hard at work supporting the US credit system over the past two months-admittedly, after first causing the greatest crisis of confidence in the history of modern financial systems. The Fed has taken on obligations, explicit or implicit, amounting to over 70 percent of GDP. The Treasury has switched away from creating a massive securities trading house toward injections of capital into a widening range of financial institutions.
But there is no strategy here, just a series of innovative (from the Fed) and belated (from the Treasury) improvisations. Mr. Obama's administration will first be preoccupied with an economic stimulus package and a program to stabilize the housing market. But very soon it will need a new strategy, based on recognition of three new realities:
- The credit crisis is now "in the real economy." Consumers are shell-shocked, firms are hunkering down for recession, and credit is now falling because of both reduced demand and tighter supply.
- The financial sector is going to shrink as a share of the economy. Part of the financial-sector expansion of the past 20 years may prove sustainable, but part was based on leverage ratios and risk models that no longer make sense.
- These financial-sector and real-economy problems are affecting almost every country in the world. There is still denial in some parts (e.g., optimistic growth forecasts for China), but the economic storm is reaching everyone and everywhere.
This situation, while unfortunate in the aggregate and a tragedy for many vulnerable individuals, actually presents a major opportunity for the United States.
The opportunity is to transform the economy by moving resources (capital and people) out of financial services and into manufacturing, technology, and other activities based on "real" (i.e., nonfinancial) innovation. This switch plays to a number of strengths in the United States: people (and capital) move relatively easily compared to other countries; we have great depth in the development of technology (our engineering schools lead the world); we are very good at creating new companies (many have tried to replicate Silicon Valley, few have even come close); and, if managed well, we will continue to have the deepest and most flexible capital markets in the world.
American companies are also extremely imaginative and make rapid, decentralized decisions when faced with sensible market incentives. All we know today is that the successful companies of the future will be based on new or newly adapted technology. The private sector will figure out the rest-ideally, guided by sensible regulation from the public sector.
The strategy for Mr. Obama is simple. His administration needs to recognize and facilitate this sea change in the allocation of resources, instead of making the mistake of trying to protect the status quo. Specifically, this means:
- Take advantage of competition. The United States has some of the best-run companies in the world. Ordinarily, the stronger companies acquire and restructure the weaker, and the weakest fail. There may be a difficult process of restructuring and consolidation in many sectors, but it would be a mistake to provide government support that will only delay necessary changes. In particular, support for auto companies can only be justified if it will produce a stronger, globally competitive, more fuel-efficient auto industry. Affected workers should be supported with money (extended unemployment benefits and a better health-care safety net) and job-retraining assistance. But the private sector should sort out the winners and the losers.
- Scale up investments in education, with an emphasis on spreading technology-related skills through the population. There should be a massive expansion in community colleges, focusing on people who only completed high school; our major engineering schools should be challenged to take on this task directly. The "high school only" vs. "completed college" productivity and income divide in the United States needs to be closed, for both equity and efficiency reasons. This will ensure competitiveness in tomorrow's global economy.
- Continue to foster immigration. The United States has benefited greatly from immigrants, who contribute critical skills to our established companies and start small businesses of all descriptions. As unemployment rises, there will be a knee-jerk reaction to cut immigration; the Obama administration needs to lead public opinion away from this short-sighted nativism. Of course, this will be easier if middle-class Americans see a promising economic future for themselves.
- Build a single, consolidated banking and securities regulator. This will not help with the current recession, but it should help head off the next bubble. We are creating, through government support, some mega-banks. Unless we counterbalance these banks, we will soon find ourselves in the unfortunate situation of Europe today, where powerful banks run rings around fragmented regulators.
- Assume global leadership. Weakness in the global economy presents a major risk to the United States. If slow adjustment in Europe morphs into serious fiscal problems, or if emerging markets suffer political instability, then (a) we will have trouble selling to the world and (b) the dollar will continue its recent appreciation. It is critical to resist the temptation of protectionism and work with other countries both to ensure continued growth in global trade and to create the broadest possible opportunities for American companies.
Our best chance is a strong, self-assured United States, with a sustainable, high rate of growth, leading the world through example and innovation. It all lies within Mr. Obama's grasp.
Simon Johnson is a senior fellow at the Peterson Institute for International Economics and a professor at MIT. He is a cofounder of the blog Baseline Scenario (http://baselinescenario.com).