Larry Summers, professor and past president of Harvard, Bill Clintons secretary of the Treasury and Obama adviser in 2009-2010, is not everyones cup of tea.
In a way, you could say that he has been done in by his arrogance. But hardly anyone disputes the fact that hes a brilliant Friedmanite economist, one who consistently cautions against the costs of government, a position that cost him his job as Obamas director of the National Economic Council.
This week, Summers wrote an op-ed piece for The Washington Post and The Financial Times entitled How to avoid a lost decade . Although the article refers to the U.S. economy, it is uncanny how some of the prognosis and recommendations can apply to Mexico.
In fact, to many Mexican analysts, the nation has already experienced a lost decade. In 2000, the PANs Vicente Fox ended 70 years of PRI rule, ushering in a new era of hope. The hopes were dashed from the outset by Foxs utter incompetence and frivolity. Fox was succeded in 2006 by Felipe Calderón, who has not fared much better. Thus, for all practical purposes, the first decade of the century was pretty much squandered.
According to Summers, even with the massive 2008-09 policy effort that prevented financial collapse and depression, the United States is now halfway to a lost economic decade. From the first quarter of 2006 to the first quarter of 2011, the U.S. economys growth rate averaged less than 1 percent a year, similar to Japan in the period its bubble burst.
During that time, the share of the population working has fallen from 63.1 to 58.4 percent, reducing the number of those with jobs by more than 10 million. The fraction of the population working remains almost exactly at its recession trough, and recent reports suggest that growth is slowing.
Beyond the lack of jobs and incomes, an economy producing below its potential for a prolonged interval sacrifices its future. Huge numbers of new college graduates are moving back in with their parents this month because they have no job or means of support. Strapped school districts across the country are cutting out advanced courses in math and science and in some cases opening school only four days a week. Reduced incomes and tax collections are the most important cause of unacceptable budget deficits at present and in the future.
Traditionally, says Summers, the U.S. economy has recovered robustly from recession as demand has been quickly renewed. Within a couple of years after the only two deep recessions of the post-World War II period those of 1974-75 and 1980-82 the economy was growing in the range of 6 percent or more, rates that seem inconceivable today. Why?
He claims that inflation dynamics defined the traditional postwar U.S. business cycle. Recoveries continued and sometimes even accelerated until they were murdered by the Federal Reserve with inflation control as the motive. After inflation slowed, rapid recovery propelled by dramatic reductions in interest rates and a backlog of deferred investment was almost inevitable.
Our current situation is very different. With more prudent monetary policies expansions are no longer cut short by rising inflation and the Fed hitting the brakes. All three U.S. expansions since Paul Volcker brought inflation back under control have run long. They end after a period of overconfidence drives the prices of capital assets too high and the apparent increases in wealth lead to excessive borrowing, lending and spending.
After bubbles burst there is no pent-up desire to invest. Instead there is a glut of capital caused by overinvestment during the period of confidence vacant houses, malls without tenants and factories without customers. Meanwhile, consumers discover that they have less wealth than they expected, less collateral to borrow against and are under more pressure than they expected from their creditors. Pressure on private spending is enhanced by structural changes.
The publishing industry, says Summers, is a vivid example. As local bookstores have given way to megastores, megastores have given way to Internet retailers and Internet retailers have given way to ebooks, two things have happened. The economys productive potential has increased and its ability to generate demand has been compromised as resources have been transferred from middle-class retail and wholesale workers with a high propensity to spend up the scale to those with a much lower propensity to spend.
What, then, is to be done? There is no time for fatalism or for traditional political agendas. The central irony of financial crisis is that while it is caused by too much confidence, borrowing and lending, and spending, it is resolved only by increases in confidence, borrowing and lending, and spending.
He claims it is false economy to defer infrastructure maintenance and replacement when 10-year interest rates are below 3 percent and construction unemployment approaches 20 percent.
Policy in other dimensions should be informed by the shortage of demand that is a defining characteristic of our economy. The Obama administration is doing important work by modernizing export controls, promoting U.S. products abroad, and reaching and enforcing trade agreements. Much more could be done through changes in visa policy, for example, to promote tourism as well as education and health services.
Summers concludes that the U.S. averted a depression in 2008-09 by acting decisively. What is needed now are flexible fiscal policies and a recognition of the harsh economic realities to get the economy back on track.