Lawrence Summers

With the release of the president’s budget, Washington has once again descended into partisan squabbling. There is in America today pervasive concern about the basic functioning of our democracy. Congress is viewed less favorably than ever before in the history of public opinion polling. Revulsion at political figures unable to reach agreement on measures that substantially reduce prospective budget deficits is widespread. Pundits and politicians alike condemn gridlock as angry movements like Occupy Wall Street and the Tea Party emerge on both sides of the political spectrum, and partisanship seems to become ever more pervasive.

All this comes at a time of great challenge. Profound changes, as emerging economies led by China converge toward the West, will redefine the global order. Beyond the current economic downturn, which is surely the most serious since the Great Depression, lies the even more serious challenge of the rise of technologies that may well raise average productivity but displace large numbers of workers. Public debt is running up in a way that is without precedent except in times of all-out war. And a combination of the share of the population that is aged and the rising relative price of public services such as healthcare and education pressure future budgets.

Anyone who has worked in a political position in Washington has had ample experience with great frustration. Almost everyone involved with public policy feels as I do that there is much that is essential yet infeasible in the current political environment. Yet context is important. Concerns about gridlock are a near-constant in American political history and in important respects reflect desirable checks and balances; much more progress is occurring in key sectors than is usually acknowledged; and American decision making, for all its flaws, stands up well in global comparison.

It is a commonplace that the missing center makes political compromise impossible. Many yearn for a return to what they imagine as an earlier era when centrists in both parties had overlapping opinions and negotiated bipartisan compromises that moved the country forward. Yet fears about the functioning of our government like those expressed today have been recurring features of the political landscape since Patrick Henry’s 1791 assertion that the spirit of the revolution had been lost. It’s sobering to consider the degree of concern about paralysis that gripped Washington during the early 1960s when the prevailing diagnosis was that a lack of cohesive and responsible parties precluded the clear electoral verdicts necessary for decisive action. While there was a flurry of legislation passed in the 1964-66 period after a Democratic landslide, what followed were the cleavages associated with Vietnam and then Watergate, all leading to President Jimmy Carter’s famous declaration of a crisis of the national spirit. Whatever the view today, there was hardly high rapport in Washington during the term of Ronald Reagan. President Bill Clinton worked hard to establish rapport and compromise with a Congress controlled by the opposition only to be impeached by the House of Representatives after a bitter struggle.

Intense division and slow change have been the norms rather than the exceptions. While often frustrating, this has not always been a bad thing. Probably there were too few not too many checks and balances as the United States entered the Vietnam and Iraq wars. By my lights and that of many others, there should have been more checks and balances on the huge tax cuts of 1981, 2001 and 2003 or on unpaid-for entitlement expansions at any number of junctures. Most experts would agree that it is a good thing that politics thwarted the effort to establish a guaranteed annual income in the late 1960s and early 1970s or the effort to put in place what would today be called a single-payer healthcare system in the 1970s.

Europe’s economic situation is viewed with far less concern than was the case six, 12 or 18 months ago. Policymakers in Europe far prefer engaging the United States on a possible trade and investment agreement to more discussion on financial stability and growth. However, misplaced confidence can be dangerous if it reduces pressure for necessary policy adjustments.

There is a striking difference between financial crises in memory and as they actually play out. In memory, they are a concatenation of disasters. As they play out, the norm is moments of panic separated by lengthy stretches of apparent calm. It was eight months from the Korean crisis to the Russian default in 1998; six months from Bear Stearns’s demise to Lehman Brothers’ fall in 2008.

Is Europe out of the woods? Certainly a number of key credit spreads, particularly in Spain and Italy, have narrowed substantially. But the interpretation of improved market conditions is far from clear. Restrictions limit pessimistic investors’ ability to short European debt. Regulations enable local banks to treat government debt as risk-free, and they can fund it at the European Central Bank (ECB) on better-than-market terms. The suspicion exists that, if necessary, the ECB would come in strongly and bail out bondholders. Remissions sometimes are followed by cures and sometimes by relapses.

There should be little disagreement across the political spectrum that growth and job creation remain America’s most serious national problem. Ahead of President Obama’s first State of the Union address of his second term, and further fiscal negotiations in Washington, America needs to rethink its priorities for economic policy.

The U.S. economy grew at a rate of 1.5 percent in 2012. Last week, the independent Congressional Budget Office projected that growth will be only 1.4 percent during 2013 – and that unemployment will rise. While the CBO says that growth will accelerate in 2014 and beyond, it nonetheless predicts that unemployment will remain above 7 percent until 2016.

A weak economy and limited job creation make growth in middle-class incomes all but impossible, add pressure to budgets by restricting tax revenue and threaten essential private and public investments in education and innovation. Worse, they undermine the American example at a dangerous time in the world.

Since the election, American public policy debate has been focused on prospective budget deficits and what can be done to reduce them. The concerns are in part economic, with a recognition that debts cannot be allowed, indefinitely, to grow faster than incomes and the capacity repay.  And they have a heavy moral dimension with regard to this generation not unduly burdening our children.  There is also an international and security dimension: The excessive buildup of debt would leave the United States vulnerable to foreign creditors and without the flexibility to respond to international emergencies.

While economic forecasts are uncertain, the great likelihood is that debts will rise relative to incomes in an unsustainable way over the next 15 years without further actions beyond those undertaken in the 2011 budget deal and the end of year agreement that averted a fall over the “fiscal cliff.” So even without the risk of self-inflicted catastrophes — like the possible failure to meet debt obligations or the shutting down of government — it is entirely appropriate for policy to focus on reducing prospective deficits.

Those who argue against a further concentration on prospective deficits on the grounds that – contingent on a forecast that assumes no recessions – the debt to gross domestic product ratio may stabilize for a decade counsel irresponsibly. Given all uncertainties and current debt levels, we should be planning to reduce debt ratios if the next decade goes well economically.

Sooner or later the American tax code will be reformed — probably sooner. Raising revenue will be the main motivation, but at a time of sharply increasing economic polarization, issues of fairness will be prominent too. There are also legitimate concerns about the complexity of current tax rules and their adverse effects on the economy.

So far, the debate has focused on scaling back provisions of the tax code that have favored activities traditionally deemed to be valuable. For example, there is talk of reducing deductions for charitable contributions, taxes paid to state and local governments, home mortgages, employer-provided health insurance and many less important provisions.

There are reasonable arguments to be made in each case. But taking only the “limit tax incentives” approach to tax reform has several major defects. First, if reform is designed to avoid perverse outcomes — such as the crushing of charitable contributions or more pressure on state budgets — then it will raise limited amounts of revenue. Second, this approach will address very little of the complexity in the code and is not likely to do much for recovery, since it will do little to increase demand. Third, it will do little to address concerns about fairness: The richest taxpayers actually make relatively little use of deductions and credits.

Writing on behalf of the Romney campaign, my friend Mike Boskin has responded to my column from last week that argued that in a number of areas of economic policy, President Obama has the superior vision. Boskin condemns what he refers to as “Obama debt” and argues that Governor Romney has a better plan that he asserts offers “a superior alternative of balanced budgets.” While I was not writing on behalf of the Obama campaign and my piece had a much broader focus than budget deficits, several responses are appropriate.

First, Boskin is correct in noting that current budget deficits and rates of debt accumulation cannot be maintained indefinitely, and that stabilizing and ultimately reducing the debt-to-GDP ratio is important if all sorts of economic horrors are to be avoided. This is a point of agreement between the two candidates–not a basis for choosing between them.

Second, Boskin blames the current high level of deficits on President Obama’s policies, but that is hard to square with the facts. When President Clinton left office in 2001, we were paying down the national debt at the rate of several hundred billions of dollars a year with budget surpluses. Since that time the Bush administration moved the United States substantially into budget deficits with large tax cuts, major military commitments to wars in Iraq and Afghanistan and a new prescription drug entitlement ‑ all undertaken without offsetting expenditure reduction or increasing revenue. Beyond these decisions, the largest factor in the current level of deficits is the worst economic downturn since the Depression ‑ a downturn that began under President Bush. People will debate the merits of President Obama’s stimulus measures ‑ though I think their positive effect on growth and employment is quite clear ‑ but this debate matters little. Government employment has been contracting, and the debate over stimulus has largely faded.

Even as our politicians disagree on a great deal, most experts can agree on the objectives of economic policy. The next president will not have succeeded in the economic area unless he accomplishes three things: Reestablishing economic growth at a rate that makes real reductions in unemployment possible. Placing the nation’s finances on a stable foundation by putting in place measures to assure that U.S. sovereign debt is declining relative to America’s wealth. Renewing the economy’s foundation in a way that can support steady growth in middle-class incomes over the next generation, along with work for all who want it.

Where are the candidates on these three issues? President Obama has recognized that the inadequacy of demand is the principal barrier to growth and has sought to bolster both public- and private-sector demand since becoming president. Recent work by the IMF has confirmed the premise of his policies: namely, that at a time when short-term interest rates are at zero, fiscal policies are especially potent. The president has also respected the independence of the Federal Reserve as it has sought to respond creatively to the challenge of increasing demand even with short-term interest rates zeroed out. And he has put the economy on track to nearly doubling exports over five years through a series of measures, such as increasing government support for exporters. He has made clear his commitment to taking advantage of current low interest rates to finance public investment and protect public-sector jobs, and to continue to promote US exports.

In contrast, Governor Romney supports immediate efforts to sharply reduce government spending even as economic slack remains and Congress—at the president’s behest—has already legislated the most draconian domestic discretionary spending cuts in history. Through some set of intellectual gymnastics, Mitt Romney concludes that a government purchasing a new weapon systems or the recipient of a tax cut buying luxury goods creates jobs, but spending on fixing schools and highways does not. He also seems comfortable involving himself in monetary policy, favoring a reduction in the supply of credit relative to current Fed policy. And his insistence that he will name China a currency manipulator on his first day as president, even before his appointees have moved into their offices, surely increases uncertainty by making a trade war possible.

If the global economy was in trouble before the annual World Bank and IMF meetings in Tokyo this past weekend, it is hard to believe that it is now smooth sailing. Indeed, apart from the modest stimulus provided to the Japanese economy by all the official visitors to Tokyo, it’s not easy to see what of immediate value was accomplished.

The U.S. still peers over a fiscal cliff, Europe staggers forward preventing crises King Canute-style with fingers in the dyke but no compelling growth strategy, and Japan remains stagnant and content if it can grow at all. Meanwhile, each BRIC is an unhappy story in its own way, with financial imbalances impeding growth in the short run and deep problems of corruption and demography casting doubt on long-run prospects.

In much of the industrial world, what started as a financial problem is becoming a deep structural problem. If growth in the United States and Europe had been maintained at its average rate from 1990 to 2007, GDP would be between 10 and 15 percent higher today and more than 15 percent higher by 2015 on realistic projections. Of course this calculation may be misleading because global GDP in 2007 was inflated by the same factors that created financial bubbles.  Yet even if GDP was artificially inflated by 5 percentage points in 2007, output is still about $1 trillion short of what could have been expected in the U.S. and EU.  This works out to more than $12,000 for the average family.

It is the mark of science and perhaps rational thought more generally to operate with a falsifiable understanding of how the world operates. And so it is fair to ask of the economists a fundamental question: What could happen going forward that would cause you to substantially revise your views of how the economy operates and to acknowledge that the model you had been using was substantially flawed? As a vigorous advocate of fiscal expansion as an appropriate response to a major economic slump in an economy with zero or near-zero interest rates, I have for the last several years suggested that if the British economy – with its major attempts at fiscal consolidation – were to enjoy a rapid recovery, it would force me to substantially revise my views about fiscal policy and the workings of the macroeconomy more generally.

Unfortunately for the British economy, nothing in the record of the last several years compels me to revise my views. British economic growth post-crisis has lagged substantially behind U.S. growth, and the gap is growing. British GDP has not yet returned to its pre-crisis level and is more than 10 percent below what would have been predicted on the basis of the pre-crisis trend. The cumulative output loss from this British downturn in its first five years exceeds even that experienced during the Depression of the 1930s. And forecasts continue to be revised downward, with a decade or more of Japan-style stagnation now emerging as a real possibility on the current course.

Whenever policy is failing to achieve its objectives, as in Britain today with respect to economic growth, there is a debate as to whether the right response is doubling down – perseverance and intensification of the existing path – or recognition of error or changed circumstances and a change in course. In Britain today such a debate rages with respect to the aggressive fiscal consolidation that the government has made the centerpiece of its economic strategy.  Until and unless there is a substantial reversal of course with respect to near-term fiscal consolidation, Britain’s short- and long-run economic performance is likely to deteriorate.

With the selection of Paul Ryan as the Republican vice-presidential candidate, it is clear both political parties agree that the central issue in the coming presidential election will be the scale and scope of government involvement in the U.S. economy. There will be disagreement over what constituted “normal” levels of spending in the past and indeed over what constitutes “spending.” But there is a widespread view in both parties that it is feasible and desirable that in the future the federal government will be no larger as a share of the overall economy than it has been historically.

Unfortunately, this aspiration is unlikely to be achieved. Even preserving the amount of government functions the U.S. had before the financial crisis will require substantial increases in the share of the economy devoted to the public sector. This is the case for several structural reasons.

First, demographic change will greatly expand federal outlays unless politicians decide to degrade the level of protection traditionally provided to the elderly. Between Social Security, Medicare and Medicaid, and other smaller programs, about 32 percent of the U.S. federal budget, or about 7.7 percent of gross domestic product, is devoted to supporting those over 65. The ratio of this age group to those of working age will rise from 1:4.6 to 1:2.7 over the next generation, implying an increase in federal spending of 5.6 percentage points of GDP, if no other adjustments are made. True, as Americans’ health and life expectancy improve, it may be appropriate to revise upward the assumed retirement age. However, it will be unlikely to counteract the expected 34 percent increase over the next generation in the share of the population that will be within 15 years of estimated life expectancy.