Arguing About Growth

Lifting the economy will require more spending now and fundamental budget reform later. William Galston and Lawrence Mishel continue their exchange on growth and the progressive agenda.

By William Galston Lawrence Mishel

Tagged EconomicsGreat Recession

William Galston: I want to begin by thanking Lawrence Mishel for joining the debate in such a civil and productive manner. [“What Anti-Growth Agenda?” Issue #22] He and I agree on the central points. Nothing that Democrats care about will be possible without sustained, vigorous economic growth, the fruits of which are widely shared. The question before us concerns means, not ends.

Let’s argue about our real disagreements. Although I believe that the Economic Policy Institute (EPI), Mishel’s organization, hasn’t focused enough on innovation, I’m happy to acknowledge that it has offered a number of proposals to stimulate growth, many of which I find congenial: a job-creation tax credit and renewing the payroll tax cut, for example. In turn, I hope that Mishel will take in the full range of what I’ve been saying since Barack Obama’s inauguration. Progressive entrepreneurship, the focus of my article in Democracy, is but one piece of the much broader agenda we need. Democrats must be able to walk and chew gum at the same time: While we attend to the imperatives of short-term recovery, we must remain focused on our long-term investment and budget deficits as well.

As Mishel says, I’ve been skeptical about the adequacy of the traditional demand-side stimulus strategy that the Administration has pursued. That’s not because I thought then, or think now, the government should stand back and do nothing, or because I thought stimulus was completely wrong-headed. Rather, I was an early convert to the thesis put forward by economists Ken Rogoff and Carmen Reinhart that financial crises differ from cyclical downturns, not only in severity, but also in kind. If it is accumulated debt that stifles demand, then it is unrealistic to expect vigorous growth to resume until policy-makers take action to reduce the debt burden.

Today, most corporate balance sheets are in good shape. Not so for households, which more than doubled their debt as a percentage of disposable income in the quarter century from 1982 to 2007, only to be left high and dry when the economy tanked. Mortgages are the epicenter of household debt, and thus of our economic woes as I understand them. Stimulus without debt relief palliates the pain without curing the disease. That’s why I’ve criticized the Administration for its failure to move early on a bold plan to reduce not only interest rates, but also principal amounts on millions of underwater mortgages that could avert foreclosure with suitable adjustments.

While I agree with EPI that allowing homeowners with underwater mortgages and weakened credit scores to refinance would be a step in the right direction, I believe that we need to act more boldly. In a New Republic piece entitled “Three Ways Obama Can Fix the Housing Crisis,” I explored serious mortgage relief proposals that had been in the public domain since 2009. Their authors showed how strategies such as immediate principal reduction in return for equity participation in future real-estate price increases could relieve pressure on hard-pressed households without blowing a hole in financial institutions’ balance sheets. I do not understand why the Administration did not take these ideas more seriously. President Obama now acknowledges that housing has been the least successful element of his Administration’s economic recovery policy.

I’ve been a staunch and consistent defender of public investment, starting with infrastructure, which our country has neglected for a generation. With record-low interest rates and millions of willing workers, now is the perfect time to jump in, as Virginia’s conservative Republican governor has recognized by successfully pushing through legislation authorizing more than $3 billion in borrowing for backlogged transportation projects. But there’s no chance that we can mobilize enough public capital to fill the accumulated infrastructure gap, now estimated at $2.5 trillion. That’s why I’ve published half a dozen articles advocating a national infrastructure bank that could leverage federal seed capital with private funds to create significant lending capacity for projects that can satisfy rigorous economic criteria. This initiative, backed by the AFL-CIO and the Chamber of Commerce among many other groups, was included in President Obama’s jobs bill, which failed to meet a 60-vote threshold in the Senate. Senior Republicans in the House have declared the idea dead on arrival.

In a Brookings Institution paper, “Priority No. 1: Creating an Agenda to Spur Job-Creating Economic Growth,” published in July 2010, I made a number of other suggestions. For example, we should invest more in education, especially community colleges, which can help build the skills that emerging economic sectors require. In addition, retrenchment under fiscal duress at the state and local level is bound to weaken federal government efforts to stimulate growth and job creation. To be sure, many states and localities exacerbated their problems by making promises during flush times that turned out to be unsustainable. But that’s no reason to leave the problem unaddressed. Instead, the federal government should initiate permanent but conditional revenue sharing, extending bridge loans to states with the enforceable expectation that these borrowers would enact binding plans for long-term fiscal reforms. More recently, I published an article arguing that whatever the flaws in the process that led to the ill-fated Solyndra decision, conservatives are dead wrong to generalize its significance. Of course government can help foster commercially viable technological innovation, as examples throughout our national history demonstrate.

While the federal government makes pro-growth investments, it must also preserve the safety net for vulnerable groups and maintain its commitments to retired Americans. Given demographic trends such as the aging of the population and the increase in child poverty, I’ve argued the federal government will have to grow as a share of GDP in coming decades. Historical averages are irrelevant to current realities.

Because the federal government will have to spend more and because it must reduce the long-term budget gap, we must rethink our national revenue structure. We need pro-growth tax reform, which could enhance fairness as well as efficiency. Not only should we end the unjustified preferences that honeycomb the tax code and use some of the proceeds to reduce tax rates; we should also look at new sources of revenue, such as a carbon tax [“Three Fights We Can Win,” Issue #20], which would stimulate the development of energy alternatives, and a value-added tax [“The 10 Percent Solution,” Issue #19], which could stimulate exports through rebates at the border that fully comply with our international trade obligations.

Even so, while the federal government will have to grow, its current fiscal trajectory is unsustainable, as most liberal economists acknowledge. We need to stabilize our national debt as a share of GDP before the rest of the world decides that we’re no longer a good credit risk. To be sure, no one knows if and when that will happen—almost certainly not next month or next year. But if it does, the consequences for economic growth will be severe. Our credit downgrade by Standard & Poor’s in August, however premature, was a warning that we ignore at our peril. Fiscal sustainability is an essential building block of a pro-growth agenda.

Accepting this objective or anything like it will force us to recognize some unpleasant truths, however. Relatively modest tweaks can stabilize Social Security indefinitely; not so for the large federal health programs. I don’t see how we can get Medicare outlays under control without major structural changes, such as instituting a system of progressive premium supports in the context of carefully designed and regulated insurance markets. That doesn’t mean accepting the Paul Ryan budget, which would force Medicare beneficiaries to finance two-thirds of their health care costs out of pocket by 2030. It does mean putting much more pressure on the fee-for-service system, which is an open-ended spending machine. It also means that those who can afford to pay higher premiums and out-of-pocket costs will have to do so. I suspect that my friends at EPI do not much like this idea. But it’s clear that a single-payer system is off the table for the indefinite future and that we can’t continue on our current course. So those who reject every version of premium support should come forward with alternatives.

That leaves the question of how employees can share more fully in the fruits of economic growth. As we saw in the latter half of the 1990s, a tight labor market is an excellent way of promoting that objective. But even with better policies and a bit of luck, it will be quite some time (if ever) before we return to that condition. In the meantime, we need a new national norm: Total compensation should rise in tandem with productivity gains. And we need new policies for meeting that norm. I don’t share Mishel’s confidence that the traditional labor agenda—a higher minimum wage, enforcement of labor standards, a true right to collective bargaining—could get the job done. In the self-contained national economy of the 1950s and 1960s, it would have. Today, it would probably accelerate the flight of capital to overseas investments, at least in the traded sectors of the economy.

I suspect that we would do better to explore innovative wage mechanisms, such as productivity-sharing. We should consider ways of rewarding firms that couple compensation and productivity increases while penalizing those that deny workers the benefits from these gains. Now that the vulnerability of the 401(k)-based retirement strategy has become clear, we should forge new replacements for the vanished defined-benefit pension system. And we should explore the possibility of additional supplements to private-sector compensation—for example, an enhanced earned income tax credit funded through an annual wealth tax of 1 percent on holdings above a high threshold. There are sound economic reasons to believe that past a certain point, vast inequalities of wealth are an obstacle to growth, and the civic consequences of allowing these gaps to widen further are not pleasant to contemplate.

In these difficult times, we need maximum feasible agreement among those who continue to believe that an intelligently active federal government can help restore vigorous economic growth that leaves few behind. That means a focus on the foundations for growth, such as education, basic research, and infrastructure. It means a focus on the engines of growth—especially innovation and new business formation. It means a fiscal policy that combines short-term stimulus with long-term restraint. And it means renewed attention to programs ensuring that people who work hard and play by the rules benefit from increases in productivity and competitiveness, both through higher wages and enhanced retirement security.

There are other matters on which Mishel and I will continue to disagree, such as trade, the effectiveness of the traditional union agenda for the twenty-first century private sector, and, I suspect, the need to institute structural reforms in Medicare. In my view, those of us who favor higher levels of public investment will have to be tough-minded about clearing fiscal space for it. We can’t just add up everything we want and call it an economic policy; we’ll have to make choices. Upper-middle-class and wealthy families will have to endure higher Medicare premiums and co-payments if we are to improve education and infrastructure.

In the end, there are limits, political and economic, to both taxation and the accumulation of debt. Hoping those limits don’t exist makes all sorts of things possible on paper but not, alas, in reality.

Lawrence Mishel responds: I thank Bill Galston for the compliment. It is important to be able to engage allies in civil but rigorous debate. I certainly like the Galston of this latest round. Gone are the claims that centrists but not progressives are interested in innovation and growth. I agree that the key discussion is identifying the means to generate “sustained, vigorous economic growth, the fruits of which are widely shared.” My comments will focus on the challenge of having a budget policy that meets our nation’s needs (a bit broader than just addressing deficits) and on closing the gap between compensation and productivity growth (the central issue in generating shared prosperity).

Galston is correct in noting that the aftermath of a financial crisis must be treated differently from your plain vanilla, high-interest-rate-caused recession, as Rogoff and Reinhart argue. As my EPI colleague Josh Bivens has stressed, this means we need to have full guns blazing to ensure we do not suffer protracted stagnation or just rely on low interest rates. The right measures here include having higher inflation targets for monetary policy and addressing the foreclosure crisis. It also means going beyond the comfort zone of deficit hawks and running large deficits to pump up demand for a number of years while deleveraging proceeds. Failure to do so will dampen the robust job growth needed to help households deleverage.

I imagine that Galston’s and my policy preferences differ, where they do, because my analysis sees the massive redistribution of income, wealth, and power over the last three decades as central to our economic developments. It was economic policy in acts of both commission and omission that has led to an economy where nearly all the wealth and income generated accrues to those in the top 1 percent, as the Wall Street protests rightfully highlight. The incomes of that group grew 224 percent from 1979 to 2007, a growth obtained by pulling in 60 percent of all income growth. In contrast, the incomes of the bottom 90 percent grew 5 percent. The wealth of the median household was lower in 2009 than in 1983.

In the years ahead, we can expect there to be sufficient growth for across-the-board gains in living standards. The same projections that the Congressional Budget Office makes that inform long-term deficit concerns also show per capita income growth of more than 60 percent over the next three decades. That is why EPI’s budget blueprint finances needed public investments and expanded social insurance with progressive taxes. I would not reject the value-added or carbon taxes that Galston proposes but certainly would not undertake them until we have first exhausted more progressive alternatives such as imposing a financial transactions tax, taxing income from work and wealth at equal rates, and having higher income taxes at the top end. And we should always recall that there would be no deficit concerns over the next ten years if we simply reversed all of the Bush tax cuts. Last, we do need to rein in health-care costs. But we should make sure that we are providing health and retirement security for our people and take into account the erosion of employer-provided insurance and pensions.

The backdrop of wage inequality and stagnation should also inform our approach to reconnecting pay and productivity growth. I understand that Galston is unenthusiastic about prioritizing a pro-labor agenda that extends collective bargaining or mandates matters such as vacations and sick leave and other traditional approaches. For the purposes of delivering income to the vast majority and offsetting employer power in the workplace and political marketplace, I do not see an alternative to low unemployment, decent and enforced labor standards, and a robust social-insurance system. Galston prefers to “explore innovative wage mechanisms, such as productivity-sharing.” This is akin to bringing a pop gun (or, worse, a plan to build one) to a battle when we need much more powerful weaponry. The fact that centrists do not have any well-developed program for dealing with the pay-productivity disconnect reflects, perhaps, that they do not take it seriously yet. Galston is more on track with pension policy, I think. EPI’s plan developed by Teresa Ghilarducci for a new universal, mandatory retirement program on top of Social Security, called Guaranteed Retirement Accounts, may be the program he is looking for.

Finally, I reject Galston’s claim that we face economic constraints in providing shared prosperity. In my view, the constraints are political and policy-related in nature. After all, we’ve had good growth for 30 years and anticipate good growth for the next 30, our current difficulties notwithstanding. Galston seems to be saying that globalization is constraining us. In his view, apparently, globalization is necessary for growth, but it simultaneously suppresses living standards for the vast majority. If so, let’s change our approach to globalization. This only reinforces the point that it is our policy regime that is getting in the way of shared prosperity

Read more about EconomicsGreat Recession

William Galston is the Ezra Zilkha Chair and senior fellow in the Governance Studies Program at the Brookings Institution and College Park Professor at the University of Maryland. From 1993 to 1995, he served as deputy assistant to the President for domestic policy.

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Lawrence Mishel is President of the Economic Policy Institute and is the co-author of The State of Working America. Mishel's research focuses on labor market trends and education.

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