TheU.S. economy will recover. It won't recover anytime soon. It is likelyto get significantly worse over the course of 2009, no matter whatPresident Barack Obama and Congress do. And resolving the financialcrisis will require both aggressiveness and creativity. In fact, themain lesson from other crises of the past century is that governmentstend to err on the side of too much caution - of taking the punch bowlaway before the party has truly started up again.
"The mistake the United States made during the Depression and theJapanese made during the '90s was too much start-stop in theirpolicies," Timothy Geithner said when I went to visit him in histransition office a few weeks ago, before he became the U.S. Treasurysecretary. Japan announced stimulus measures even as it was cuttingother government spending. Franklin D. Roosevelt flirted with fiscaldiscipline midway through the New Deal, and the country slipped backinto decline.
Geithner arguably made a similar miscalculation himself last year asa top Federal Reserve official who was part of a team that allowedLehman Brothers to fail. But he insisted that the Obama administrationhad learned history's lesson.
"We're just not going to make that mistake," Geithner said. "We'renot going to do that. We'll keep at it until it's done, whatever ittakes."
Once governments finally decide to use the enormous resources attheir disposal, they have typically been able to shock an economy backto life. They can put to work the people, money and equipment sittingidle, until the private sector is willing to begin using them again.
But while Washington has been preoccupied with stimulus andbailouts, another, equally important issue has received far lessattention - and the resolution of it is far more uncertain. What willhappen once the paddles have been applied and the economy's heartstarts beating again? How should the American economy be remade? Aboveall, how fast will it grow?
That last question may sound abstract, even technical, compared withthe current crisis. Yet the consequences of a country's growth rate arenot abstract at all. Slow growth makes almost all problems worse. Fastgrowth helps solve them. As Paul Romer, an economist at StanfordUniversity, has said, the choices that determine a country's growthrate "dwarf all other economic-policy concerns."
Growth is the only way for a government to pay off its debts in arelatively quick and painless fashion, allowing tax revenue to increasewithout having to raise tax rates. That is essentially what happened inthe years after World War II. When the war ended, the U.S. government'sdebt equaled 120 percent of the gross domestic product (more than twiceas high as its likely level by the end of next year). The rapideconomic growth of the 1950s and 1960s - more than 4 percent a year,compared with 2.5 percent in this decade - quickly whittled that debtaway. Over the coming 25 years, if growth could be lifted by justone-tenth of a percentage point a year, the extra tax revenue wouldcompletely pay for an $800 billion stimulus package.
Yet there are real concerns that the U.S. economy will not growenough to pay off its debts easily and ensure rising living standards,as happened in the postwar decades, because two of the economy's mostpowerful recent engines have been exposed as a mirage: the explosion inconsumer debt and spending, which lifted short-term growth at theexpense of future growth, and the great Wall Street boom, whichdepended partly on activities that had very little real value.
Richard Freeman, a Harvard economist, argues that the U.S. bubbleeconomy had something in common with the old Soviet economy. The SovietUnion's growth was artificially raised by huge industrial output thatended up having little use. America's was artificially raised bymortgage-backed securities, collateralized debt obligations and eventhe occasional Ponzi scheme.
Where will new, real sources of growth come from? Not from WallStreet, probably. Nor, obviously, from Detroit. Nor from SiliconValley, at least not by itself. Well before the housing bubble burst,the big productivity gains brought about by the 1990s technology boomseemed to be petering out.
So for the first time in more than 70 years, the epicenter of theU.S. economy can be placed in Washington. And Washington won't merelybe given the task of pulling the economy out of the immediate crisis.It will also have to figure out how to put it on a more sustainablepath - to help it achieve fast, broadly shared growth and do so withoutthe benefit of a bubble. Obama said as much in his inauguration speechwhen he pledged to overhaul Washington's approach to education, healthcare, science and infrastructure, all in an effort to "lay a newfoundation for growth."
For centuries, people have worried that economic growth had limits -that the only way for one group to prosper was at the expense ofanother. The pessimists, from Malthus and the Luddites and on, havebeen proved wrong again and again. Growth is not finite. But it is alsonot inevitable. It requires a strategy.
The upside of a downturnTwo weeks after the election, Rahm Emanuel, Obama's chief of staff,appeared before an audience of business executives and laid out an ideathat Lawrence Summers, Obama's top economic adviser, later described tome as Rahm's Doctrine. "You never want a serious crisis to go towaste," Emanuel said. "What I mean by that is that it's an opportunityto do things you could not do before."
In part, the idea is standard political maneuvering. Obama had anambitious agenda - on health care, energy and taxes - before theeconomy took a turn for the worse in the autumn, and he has an interestin connecting the financial crisis to his pre-existing plans. "Thingswe had postponed for too long, that were long term, are now immediateand must be dealt with," Emanuel said in November.
Of course, the existence of the crisis does not require the Obamaadministration to deal with education or health care. But the fact thatthe economy appears to be mired in its worst recession in a generationmay well allow the administration to confront problems that havefestered for years.
The counter-argument is hardly trivial - namely, that the financialcrisis is so serious that the administration should not distract itselfwith other matters. That is a risk, as is the additional piling on ofdebt for investments that might not bear fruit for a long while. ButObama may not have the luxury of trying to deal with the problemsseparately. This crisis may be his one chance to begin transforming theeconomy and avoid future crises.
In the early 1980s, an economist named Mancur Olson developed atheory that could fairly be called the academic version of Rahm'sDoctrine. Olson, a University of Maryland professor who died in 1998,is one of those academics little known to the public but famous amonghis peers. His seminal work, "The Rise and Decline of Nations,"published in 1982, helped explain how stable, affluent societies tendto get in trouble. The book turns out to be a surprisingly useful guideto the current crisis.
In Olson's telling, successful countries give rise to interestgroups that accumulate more and more influence over time. Eventually,the groups become powerful enough to win government favors, in the formof new laws or friendly regulators. These favors allow the groups tobenefit at the expense of everyone else; they not only end up with alarger piece of the economy's pie but also do so in a way that keepsthe pie from growing as much as it otherwise would. Trade barriers andtariffs are the classic example. They help the domestic manufacturer ofa product at the expense of millions of consumers, who must pay highprices and choose from a limited selection of goods.
Olson's book was short but sprawling, touching on everything fromthe Great Depression to the caste system in India. His primary casestudy was Britain in the decades after World War II. As an economic andmilitary giant for more than two centuries, it had accumulated one ofhistory's great collections of interest groups - miners, financialtraders and farmers, among others. These interest groups had soshackled Britain's economy by the 1970s that its high unemployment andslow growth came to be known as "British disease."
Germany and Japan, on the other hand, had to rebuild their economiesand political systems after the war. Their interest groups were wipedaway by the defeat. "In a crisis, there is an opportunity to rearrangethings, because the status quo is blown up," Frank Levy, an economistat the Massachusetts Institute of Technology and an Olson admirer, toldme recently. Olson's insight was that the defeated countries of WorldWar II didn't rise despite crisis. They rose because of it.
The parallels to the modern-day United States, though not exact, areplain enough. America's long period of economic pre-eminence hasproduced a set of interest groups that, in Olson's words, "reduceefficiency and aggregate income." Home builders and real estate agentspushed for housing subsidies, which made many of them rich but made thereal estate bubble possible. Doctors, drug makers and other medicalcompanies persuaded the U.S. government to pay for expensive treatmentsthat had scant evidence of being effective. Those treatments are theprimary reason the United States spends so much more than any other onmedicine. In these cases, and in others, interest groups successfullylobbied for actions that benefited them and hurt the larger economy.
Surely no interest group fits Olson's thesis as well as Wall Street.It used an enormous amount of leverage - debt - to grow tounprecedented size.
In good times - or good-enough times - the political will to beatback such policies doesn't exist. Their costs are too diffuse, andtheir benefits too concentrated. A crisis changes the dynamic. It's anopportunity to do things you could not do before.
Britain's crisis was the Winter of Discontent, in 1978-79, whenstrikes paralyzed the country and many public services shut down. Theresulting furor helped elect Margaret Thatcher as prime minister andallowed her to sweep away some of the old economic order. Herlaissez-faire reforms were flawed in some important ways - taken to anextreme, they helped create the current financial crisis - and theywere not the only reason for England's turnaround. But they made adifference. In the 30 years since her election, Britain has grownfaster than Germany or Japan.
The investment gapOne good way to understand the current growth slowdown is to thinkof the debt-fueled consumer-spending spree of the past 20 years as asymbol of an even larger problem. As a country, the United States hasbeen spending too much on the present and not enough on the future.Americans have been consuming rather than investing. They are sufferingfrom investment-deficit disorder.
You can find examples of this disorder in just about any realm ofAmerican life. Walk into a doctor's office and you will be asked tofill out a long form with the most basic kinds of information that youhave provided dozens of times before. Walk into a doctor's office inmany other developed countries and that information - as well as yourmedical history - will be stored in computers. These electronic recordsnot only reduce hassle; they also reduce medical errors. Yet Americanscannot avail themselves of this innovation even though the UnitedStates spends far more on health care, per person, than any othercountry. Americans are spending their money to consume medicaltreatments, many of which have only marginal health benefits, ratherthan to invest it in ways that would eventually have far broaderbenefits.
Along similar lines, Americans are indefatigable buyers of consumerelectronics, yet a smaller share of households in the United States hasbroadband Internet service than in Canada, Japan, Britain, South Koreaand about a dozen other countries. Then there is education: Americaonce led the world in educational attainment by a wide margin. It nolonger does. And transportation: A trip from Boston to Washington, onthe fastest train in the country, takes six and a half hours. A tripfrom Paris to Marseille, roughly the same distance, takes three hours -a result of the French government's commitment to infrastructure.
Tucked away in the many statistical tables at the CommerceDepartment are numbers on how much the U.S. government and the privatesector spend on investment and research - on highways, software,medical research and other things likely to yield future benefits.Spending by the private sector has not changed much over time. It wasequal to 17 percent of GDP 50 years ago, and it is about 17 percentnow. But spending by the government - federal, state and local - haschanged. It has dropped from about 7 percent of GDP in the 1950s toabout 4 percent now.
Governments have a unique role to play in making investments for twomain reasons. Some activities, like mass transportation and pollutionreduction, have social benefits but not necessarily financial ones, andthe private sector simply won't undertake them. And while many otherkinds of investments do bring big financial returns, only a fraction ofthose returns go to the original investor. This makes the privatesector reluctant to jump in. As a result, economists say, the privatesector tends to spend less on research and investment than iseconomically ideal.
Historically, the government has stepped into the void. In the 1950sand 1960s, the GI Bill created a generation of college graduates, whilethe Interstate System of highways made the entire economy moreproductive. Later, the Defense Department developed the Internet, whichspawned AOL, Google and the rest.
The idea that the government would be playing a much larger role inpromoting economic growth would have sounded radical, even amongDemocrats, until just a few months ago. After all, the Europeancountries that have tried guiding huge swaths of their economies - thathave kept their arms around the "commanding heights," in Lenin'senduring phrase - have grown even more slowly than the United States inrecent years.
But the credit crunch and the deepening recession have changed thediscussion. The U.S. government now seems as if it was doing too littleto take advantage of the U.S. economy's enormous assets: its size, itsopenness and its mobile, risk-taking work force. The government is alsoone of the few large entities today able to borrow at a low interestrate. It alone can raise the capital that could transform the economyin the kind of fundamental ways that Olson described.
"This recession is a critical economic problem - it is a crisis,"Summers told me recently. "But a moment when there are millions ofpeople who are unemployed, when the federal government can borrow moneyover the long term at under 3 percent and when we face long-run fiscalproblems is also a moment of great opportunity to make investments inthe future of the country that have lagged for a long time."
He then told a story that John F. Kennedy liked to tell, about anearly-20th-century French marshal named Hubert Lyautey. "The guy saysto his gardener, 'Could you plant a tree?'?" Summers said. "Thegardener says, 'Come on, it's going to take 50 years before you seeanything out of that tree.' The guy says, 'It's going to take 50 years?Really? Then plant it this morning."'
