Jobs are growing slowly. The eurozone walks the precipice. Congress can’t work with itself. Businesses are unsure of what’s coming from Washington. Our two panelists explain the issues at stake for the economy in 2012. Excerpt from the program on January 20, 2012.

MICHAEL BOSKIN, Professor of Economics and Senior Fellow, Hoover Institution, Stanford University; Chair, President’s Council of Economic Advisers under President George H.W. Bush.

CHRISTINA ROMER, Professor of Economics, University of California, Berkeley; Immediate Past Chair, President Obama’s Council of Economic Advisers

MARY CRANSTON, Senior Partner, Pillsbury Winthrop Shaw Pittman; Past Chair, Commonwealth Club Board of Governors – Moderator

 

CHRISTINA ROMER: The United States’ economy is recovering, but I couldn’t agree more with Michael Boskin that it’s much too slow. One way to get a sense of that: Last month (December 2011), there was a lot of joy over the employment numbers. We added 200,000 jobs in the month of December. That was obviously good; it’s a lot better than we had been doing; it’s so much better than back in the heart of the recession when we were losing three-quarters of a million jobs every month. But fundamentally, 200,000 jobs is just not nearly enough. Given the hole we are in, it would take a good eight years before we actually got back to the employment levels or the trend that we were on beforehand. Even if that kind of growth continues, I think it’s completely unacceptable.

Michael pointed out, and the World Bank has pointed out, [that] one of the biggest risks that we face is what’s going on in Europe. That really is a ticking time bomb in terms of the damage that it could do to their own economy, and obviously to all of their trading partners and their partners in the financial system around the world. That is why it is so incredibly in our interest that, as Michael put it, they “get their act together.” The one thing that does give me hope is that the nightmare scenario is such a nightmare. Everyone in Europe understands that if a number of countries default, if countries leave the euro, if that system breaks up, it will be devastating to their financial system, to their real economy, to the people in the eurozone, and I think that’s why they are likely to muddle through. As hard as it’s going to be, I think that’s why that’s the most likely outcome, and that’s why there’s a hope that we will

continue to keep growing, keep expanding. But it needs to be so much faster.

MICHAEL BOSKIN: To give some brief perspective to that, we’ve had two other really severe recessions since World War II – in the mid-’70s and early ’80s – and out of those recessions, we grew at six or seven percent for several years. This time around, we’re growing in the twos. That being said, the employment situation has been lagging even that modest growth, so we’re half-speed at best on GDP and well under that on the labor market recovery. There are many reasons for that, but just in perspective, it’s a lot better than the economy not growing, or growing even more slowly and creating no jobs. But it is slow growth, especially for recovery from a deep recession.

MARY CRANSTON: We are getting a number of audience questions about employment and job growth. What do you think needs to happen in the United States or globally to stimulate job recovery? What do you see as the structural changes that are making this different than the prior recoveries?

ROMER: Let me pick up where Michael left off, which is [that] we are obviously growing much too slowly, and slower than coming out of some other deep recessions, but it’s very important to understand why. Something like the 1982 recession – let’s understand what was going on then. Inflation had gotten high. Paul Volker in the Federal Reserve jacked interest rates up to astronomical levels. That crunched housing; that crunched consumer spending. Then, when inflation was down, they could turn the spigot back on. Interest rates came down, and we were off to the races. Construction came back, and consumer spending came back. That’s not what went on in this recession. This recession was born of a bursting of a housing bubble. Interest rates started at very low levels, and they quickly went down to zero in terms of what the Federal Reserve was doing. We don’t have the normal drivers coming out of one of those severe, monetary-policy-caused recessions. We’ve got a big overstock of housing; we’re probably not going to have that surge of construction for a very long time. We are facing fundamental headwinds coming from how we got into this mess, as well as the risks in Europe. If you take that as the understanding, that we have inadequate demand, there’s lots more I think the government can and should be doing.

The Federal Reserve could be a lot more helpful. They were very good during the crisis – they held together what was a terrifying meltdown of our financial system – but maybe in the last year and a half they have not been as aggressive as they could have been to help us get a stronger recovery. We have a terrible problem in the housing sector, and one of the things that we’re learning is [that] underwater homeowners – people who owe more on their mortgages than their homes are worth – are a drag on the economy. Basically, people with high debt loads don’t want to spend; they don’t want to remodel their houses; they tend to be very nervous, as they naturally would be. We need a way to get rid of that negative equity. I wouldn’t support the government just paying for it, but we should be taking policies that encourage the financial sector to be renegotiating those underwater mortgages.

The [final] thing I think we need is a comprehensive fiscal plan. We have a terrible long-run deficit, and we had a very good bipartisan fiscal commission that came out with a plan for how to do it – that so-called “grand bargain.” We need to do it. If we take the actions that get our long-run fiscal house in order, that gives us the space to do what we need to do right now to put people back to work. I was a big proponent, when I was in the administration, of a tax cut for businesses that do what we actually want them to do, which is hire people. Those kinds of fiscal actions would be very smart policies now, if they’re combined with a sensible long-run plan so we know that the deficit gets under control over the longer run.

BOSKIN: I would agree that the origins of the recession were heavily in the bursting of the housing bubble produced by the Fed keeping interest rates too low for too long, and the serial social engineering of housing, and a lot of bad decisions by borrowers and lenders on Wall Street and Main Street. All that, I think we sort of roughly agree on.

I have a somewhat different view of the efficacy of the fiscal policy of the [Obama] administration and of the last administration. It actually was not well designed. It was very poorly implemented. Sadly, Christy [Romer] didn’t get to design it. It was basically socially engineered on Capitol Hill to do a lot of stuff that had very low pay-off and was not really devoted to what was needed at the time, in early 2009, when there were massive private sector layoffs. 

I think the idea of a new fiscal stimulus is not a good idea. If you look at the CBO’s estimates of the cost of the fiscal stimulus of 2009, it wound up costing between $300,000 and $1.1 million a job, if you take the range of job estimates they do. Some people think that it actually hurt the economy. I wouldn’t go that far, but I would say that – combined with the other social engineering that President Obama pushed – it generated, number one, some depression on spending, and number two, a great uncertainty, that greatly reduced the ability of the private sector to plan, manage, invest and hire.

I would have a somewhat overlapping, but somewhat different perspective than Christy on what ought to be done. Number one, I think the most important thing is [that] we need a lot more stability in our fiscal system, in our tax system, and in our monetary policy. I think the Fed took a small step by saying it’s going to start putting out forecasts of interest rates. They should spend a lot more time letting the market have some idea of their exit plan from their massive expansion of their balance sheet. It may be in the future – it may be pushed back longer than I would like it – but people right now have no idea when the government’s going to get out of the housing market, get out of the mortgage-backed securities, get out of the treasury market, et cetera. That’s really important.

I also think it’s important to reduce the costs that have been added, and are in the process of being added, on business to hire workers. I was for, in 2008 and early 2009, a large temporary payroll tax cut, not because I thought it was the best thing to do, but because there was going to be a large expenditure that I thought would not really wind up being nearly as productive as it might be; there was very little infrastructure spending; it was very ineffective. It’s very hard to do infrastructure spending in short-term stimulus, as Harvard’s Ed Glaeser, for example, has demonstrated. It didn’t go to the areas with the highest unemployment, or where there was the worst housing bursting bubble. It didn’t go to where it was most effective. It was very slow. It was politicized. The city of Los Angeles’ controller said it cost $2 million in jobs for the $110 million L.A. got. I think it was just not decided well for short term. This nation has infrastructure needs; they ought to be dealt with in the multi-year legislative process. Some of them are federal, and we ought to support those.

I would say that the biggest thing we can do is give a much more stable fiscal policy. I would agree with the long-term deficit reduction Christy mentioned, but I think it’s much more important that we combine that with sizable medium-term deficit reduction, gradually phased in – the economy’s still soft – not just dealing with the very long-term costs of Social Security and Medicare, as important as those are, but dealing with the big expansion of government and additional costs being imposed on the private sector. That would be a very good thing to stimulate the economy.

The Simpson-Bowles commission to which [Romer] referred proposed a much broader-base, much lower [tax] rate – lower than current policy, let alone current law. The top rate would come down well below 35 percent into the 20s. Some of the extra revenue generated from that would go to deficit reduction. That would help the economy. I think the evidence is that it’s very important how you deal with a deficit. The studies of all the OECD countries since World War II and their attempts to consolidate their budgets have demonstrated that it’s important that it be overwhelmingly on the spending side, and that taxes should only be a minority partner in that battle. The successful ones, in the sense that they didn’t cause recessions and successfully consolidated a budget, averaged about six dollars in spending cuts for every dollar of tax increase. It’s important [that] we reduce the medium-term and long-term deficit, and [that] it be done overwhelmingly on the spending side. 

ROMER: You’ve got to let me jump in here. There is so much disinformation about the fiscal stimulus. The one slightly silver lining to this horrible cloud that we have been under is that it has generated tremendous research on the effects of fiscal policy. What had been kind of a dead field is now the hottest thing for our brightest graduate students to be looking at. What those studies are consistently finding is that both tax cuts and spending increases actually stimulate the economy, and when people – whether they’re looking back in time, or at cross-section evidence of states in the United States, or specifically at the Recovery Act – what they come out with is that in fact it has done very much what the administration said it would do, which is to save or create some 3 million jobs.

Think about the Recovery Act. About a third of it was tax cuts. Another big chunk of it was money for unemployment insurance. That money doesn’t disappear. Yes, it helps to create jobs, but when you give people a tax cut, they buy things that they like with it, and when you give an unemployed family unemployment insurance, they hold body and soul together. It’s not as though that money disappears. In fact, it has its useful purpose and, in some sense, the job creation is a side benefit. Likewise, when we spent money on infrastructure, on clean energy, that created something of value besides creating the jobs.

When we go forward and have to do a fiscal consolidation – because we do have an unsustainable long-run budget deficit – what most experts will tell you is [that] it is such a big problem that there’s no way you’re going to solve it if you only do it on the spending side, or you only do it on entitlement spending, or you only do it on tax revenues. We’re going to have to fire on all cylinders to actually get this thing under control, and that’s something certainly that the Bowles-Simpson commission did emphasize.

CRANSTON: We have extreme political polarization in this country around the question of tax cuts or spending cuts, which adds to the complication of the problem. If you were given a magic wand, how would you put in place the ideal policy for taxation and entitlement reform?

BOSKIN: I’m going to take three seconds though. The CBO’s range of estimates [of jobs created by the Recovery Act] is 700,000 to 3 million from the research. That’s why it goes from almost $300,000 a job to $1.1 million. I supported the extension of unemployment insurance; now it’s so long that we should be combining it with training, for both humanitarian and incentive reasons.

Let me come back to what ought to be done. First, on the longer term, Social Security should be easy to do. Nobody’s benefits have to be cut; nobody’s taxes have to be raised. The current tax system is fine. The payroll tax – if we switch from wage-indexing to price-indexing of initial benefits – that would mean everybody’s benefits would go up with inflation; nobody’s real benefits would be cut relative to today – that would eliminate the entire deficit. I would combine it with a slightly higher retirement age in the distant future, and I’d also raise the benefits a bit for people at the bottom.

Medicare I think is a very, very difficult problem, but the only way forward is a version of the Premium Support Plan proposed by Alice Rivlin and Paul Ryan and, more recently, by Congressman Ryan and Senator Wyden, where the subsidies were phased down as income went up. We all should agree that before we ask well-off people to pay higher taxes, we ought to reduce the subsidies that go to them. That’s the second point. We don’t know whether that’ll be enough. There’s a lot of things driving health-care spending – economists argue even about how much of it’s really inflation and how much of it’s quality improvement – but that ought to be the place to start.

On the medium term, I would just gradually phase spending from the current 24-25 percent of GDP down to 20 percent or so. That’s a little bit higher than it was in 2000. We’ve accomplished that; in the ’80s and ’90s, we had a five percentage-point reduction and we had very good economic times, so that’s doable if it’s done gradually. I would take the programs, and I’d try to make them a lot more effective and efficient. We have 47 job-training programs. Job training is a serious issue. How can a federal government really run 47 effective job-training programs? What happened? In the stimulus bill, we added another one for green energy; 9 percent of the people got jobs. We need to really, really get into the structure of the government, and reform it to get a lot more out of programs that are targeted to people who really need them, and made a lot more effective, and for the government to shut down programs – and reduce and consolidate programs – that are not very effective. From the IT purchasing, to the fact that we have a bloated civilian labor force that’s [aging] – 45 percent will retire in the next 10 years – it should be doing what most private businesses are doing, and let some attrition of that – maybe half of it – and improve the services to be what’s really needed, with technology and one-stop shopping and things of that sort.

Some of this would occur on the defense side, some of it on the discretionary side, and in the medium and longer term, a lot of it would occur on the Social Security and Medicare side.

On the tax system, we very badly need lower rates on a broader base. It’s not popular for people voting, but the most important thing is to get the corporate rate down, which is the most important thing for our economic growth according to the OECD. That’s very important, but we ought to lower personal rates on a broader base with far less loopholes and have a modified, two- or three-rate system where the top rate’s the same rate as the corporate rate, and they’re both in the 20s, not in the 30s or 40s.

ROMER: We both agree that the long-run fiscal situation is a disaster. We both agree that Social Security is a small part of the problem, and probably could be fixed pretty easily; that the main thing driving our long-run budget deficit is rising government spending on health care; and we even agree [that] we’ve got to change the tax system, that the sensible way to reform both corporate taxes and individual taxes is, if possible, reduce the rates and broaden the base. Get rid of the loopholes and all of that in the system.

Let me just pick up on the corporate tax side. It’s a little easy to quote the OECD study that says, “We have the highest corporate tax rates.” That’s the stated rate. What we all know is that there are so many loopholes and sweetheart deals, that what American corporations pay at income tax is actually not high relative to other countries. That doesn’t mean we shouldn’t change it, because it would be more sensible; it’s basically very unfair to have some corporations paying much more tax than others because they had the better lobbyist. I absolutely support that, and the president supports that; he’s put corporate tax reform as a big issue. It’s hard: everybody likes lowering rates, and nobody likes giving up their special sweetheart deal, so actually getting a sensible [bill] through Congress is a really hard thing to do.

The one thing I wanted to mention is that Medicare and Medicaid are the government programs that are projected to grow dramatically, mainly because health-care spending per person is rising over time. Figuring out how to deal with that is incredibly important. All of the proposals about premium support – they sound OK until you get into the guts of them. When the Congressional [Budget] Office looks at those proposals, fundamentally what they are is greatly cutting the amount of support that the government gives, so that the average person – 20 or 30 years from now, under those programs – would not be getting nearly the benefits that they’re getting now. We have to decide: Is that what we’re willing to do, or do we want to have a proposal where we work harder to keep the existing system, and to make it much more cost-efficient, and to work as hard as we can, as we did with the Affordable Care Act, to try to get efficiency improvements and improve the incentives for providers so we get good quality at lower costs? I’d much rather stick with that system and make it work, and continue our obligation to our seniors and poor and disabled Americans.

BOSKIN: There’s a debate about this, but if we’re talking about cutting, let’s be clear that we’re talking about slowing the rate of growth.

CRANSTON: What is your overall assessment of California’s prospects?

BOSKIN: California is a great place. But California has gotten into a big ditch. With 12 percent of the country’s population, California has one third of the welfare recipients, and 25 percent of the Medicaid spending. If you look at the structure of what the government spends on, it’s been forced – because of the collapse in revenue – to mitigate the spending, but it still spends in very ineffective ways.

ROMER: California had problems before this recession started. We have a very, very dysfunctional budget system, and it absolutely needs to be fixed, but the other thing to realize is [that] this recession has been particularly hard on California. California was one of the places were the housing bubble was the biggest, and therefore it’s the place where the bursting was some of the biggest and some of the most detrimental.