SEARCHING FOR GROWTH
THE ADVANCED ECONOMIES' RECENT ATTEMPT to deal with the persisting economic crisis through unprecedented monetary easing and fiscal tightening, an approach critics say soothed the financial sector at the expense of the real economy, has come under assault. The International Monetary Fund is leading the voices calling for a relaxation of austerity. That chorus has been joined by others including the U.S. Federal Reserve, governments of the European “periphery,” and an array of economists who are changing their tune. Yet with the underlying financial/sovereign debt issues unresolved, and earlier efforts at fiscal stimulus having proved inadequate, some fear that letting up on austerity while GDP growth remains elusive could re-arouse the crisis. Around the world, debt, unemployment, and slow-growth remain worse than historic norms. The central banks don't necessarily have the answer; the Bank of Japan is now all-in on quantitative easing, the European Central Bank has cut rates, and the Fed suggests it could step up QE, but the impact is questionable. The search is now on for new growth triggers. This WIBR will survey the current economic scene and then review three other potential areas for economic stimulation: tax reform, energy production, and trade expansion.
AUSTERITY FAILED, ASSAILED – The IMF, traditionally a promoter of fiscal restraint, had a different message at its Spring Meetings in April. Its latest projections cut estimates for world GDP growth – a serious development – blaming government spending curbs in the U.S. and Europe, and IMF Managing Director Christine Lagarde declared, “What we need is a full-speed global economy – growth that is solid, sustainable.” The Fund gave its blessing to the central banks' easing, including Japan's aggressive QE program announced in early April. On the fiscal side, Lagarde has been pressing the Germans to let up on austerity imposed on the debt-ridden Eurozone countries, which have themselves – governments and populations – been objecting to the onerous fiscal demands of the EU bureaucracy. This is not new: last October, Lagarde clashed with German Finance Minister Wolfgang Schaeuble over whether Greece should have more time to meet budget-cut targets, and the question of “growth-friendly fiscal consolidation” moved onto the agenda.
More recently, austerity has slipped further out of favor. In early May Lagarde chided Washington for contractionary policies, citing the sequester and urging the U.S. to “consolidate less in the short term.” In the same May 7 address, she acknowledged that the IMF “underestimated... the consequences” of the austerity it demanded of Greece, commending the recent European Commission decision to give France and the Netherlands more time to meet deficit-cut targets.
Wanted: Fiscal Consolidation... in the Future: In advance of the May 9-10 Group of Seven Finance Ministerial, a U.S. Treasury official declared, “Now the focus needs to shift to boosting demand and employment.... It's important to recalibrate the pace of fiscal consolidation.” After the meeting it was announced that, “Everyone is clear that there needs to be credible medium-term fiscal consolidation... We also agreed that there needs to be flexibility.” Though there were reports that the German, British, and Canadian ministers were uncomfortable with it, this is now the popular formulation: focus on growth now, push austerity off to the “medium-term.” Meanwhile, the anti-austerity view got an unexpected boost when the influential paper by Harvard economists Carmen Reinhart and Kenneth Rogoff, which claimed that a public debt-to-GDP ratio of 90% was the cap beyond which an economy cannot grow, was shown to rely on faulty methodology.
THE ECONOMY HERE – How bad is the growth picture? By the preliminary estimate, U.S. first-quarter GDP grew at a 2.5% (annualized) pace. While better than the feeble previous quarter, it is an anemic rate that fell below expectations. Declines in government spending and a fall in business investment, manufacturing activity, retail sales, and exports dragged down growth, which was largely propped up by an inventory re-build. The brighter data points – an improving housing sector and a stock market surge both underwritten by aggressive monetary easing, a rise in personal spending, and an increase in government revenues – were inadequate to change the picture, and most economists no longer project 2013 GDP growth near the 3% range. The private sector is continuing to recover, just not enough to overcome the decline in government spending, leaving the growth rate too low to lift the economy out of its post-recession doldrums.
Nonetheless, the expectations for April job gains were exceeded when the non-farm payrolls report showed a net 165,000 jobs added (11,000 were lost in the government sector), along with upward revisions for the previous two months and a tick down in the unemployment rate to 7.5%. Even more encouraging, weekly unemployment claims have been trending down. As with GDP growth, however, jobs are not being added fast enough to make up ground lost in the recession. Moreover, April unemployment improved largely because the labor force participation rate remained at a low 63.3% and temporary and part-time work rose.
Therefore, few are predicting a significant near-term decline in the jobless rate, and the Federal Reserve is thus unlikely to wind down its $85 billion monthly bond purchases or raise interest rates this year, steps it vows not to take until unemployment falls to 6.5% and inflation heads above 2.5%. In fact, the Fed said on May 1 that it “is prepared to increase or reduce the pace of its [bond] purchases to maintain appropriate policy accommodation.” It “continues to see downside risks” to the economy – thus the new suggestion it could “increase” quantitative easing if growth should slow – noting that “fiscal policy is restraining economic growth.”
THE ECONOMY ABROAD – Global trade is reflecting the sub-par performance of economies abroad. Trade decelerated sharply in 2012 and is projected to remain depressed this year. Europe is the key culprit, as both imports into Europe and intra-EU trade fell. As the World Trade Organization reported in a statement bolstering the anti-austerians, “Significant downside risks [to global trade] remain centered on the euro crisis and the pace of fiscal contraction in developed economies.” Despite monetary easing by the European Central Bank, the EU remains in recession.
Japan did get a boost from its central bank's QE plunge; the IMF projects growth in the 1.5% range this year and next, though its underlying problems remain unsolved. Bad for everyone's exports, China's growth is slowing. Other developing nations are worried too. “Europe [and] the U.S. adopted quantitative easing.... What happens if they withdraw from QE – that’s our present concern,” said India’s finance minister at an April G20 meeting. More immediately, “Weaker growth across most advanced markets is now being felt in the emerging world as well,” according to a HSBC analyst.
A GROWTH AGENDA – Tax Reform: And so, the search is on for new paths to growth. Few dispute that the U.S. tax code is due for an overhaul, and most think that ought to be good for the economy given the distortions inherent in the current turgid system. Among the elements of pro-growth tax reform that have wide appeal: lowering corporate and (some) individual income tax rates, simplifying the system, and closing loopholes and poorly targeted tax breaks.
Of course, taxation is a highly partisan issue. Yet there has been movement this year. The two key figures on the issue – House Ways & Means Committee Chairman Dave Camp (R-MI) and Senate Finance Committee Chairman Max Baucus (D-MT) – have been working together, and the Joint Committee on Taxation just released a 568-page report including recommendations of congressional bipartisan tax reform working groups and outside organizations. Camp and Baucus are soliciting more public input online, and Camp intends to report a tax reform bill out of his committee this year. The White House has expressed interest, too.
Still, the consensus on the need for reform hardly means there is consensus on substance. There are intra-party disagreements, but largely, Republicans want to lower rates more than Democrats do and don't want to use tax reform to raise revenue. Some Democrats would like to further increase taxes on the wealthy (proposed in the President's budget request), an idea rejected by Republicans, who would like to see entitlement reform as part of a tax package. Corporate tax reform might be easier, as all agree it should be revenue-neutral and close loopholes. But which loopholes? That is a highly charged political question on both the corporate and the individual side. Addressing the corporate tax system also raises the question of taxes on foreign earnings. Republicans largely favor the territorial system followed by most countries, which allow foreign profits to be taxed where it is earned. Some Democrats, focused on “re-shoring” jobs, would like to immediately tax corporate money earned abroad. There is also Republican resistance to moving corporate tax reform on its own because it might disadvantage small businesses that file as individuals. Also under consideration, though far from agreement, is a proposal to tie tax reform to legislation raising the debt ceiling, a measure that must pass by the fall.
Despite such divergent views, there appears to be room for compromise, and a pro-growth tax reform deal, one that helps the economy grow without worsening the federal balance sheet, just might be doable even in the currently difficult Washington environment.
Energy: The last half-decade has brought a huge turn-around in the U.S. energy picture. The breakthroughs have come in the exploitation of fossil fuels, which “is going to be a real driver of economic growth,” as Republican economist Douglas Holtz-Eakin put it. The advanced technologies of hydraulic fracturing and horizontal drilling, and new discoveries of oil and gas reserves, are boosting job growth, domestic manufacturing, and an improving trade balance – oil imports are at a 17-year low as production is up over 37% in the past two years, while the U.S. will soon produce more natural gas than Russia. A study by the Minneapolis Fed showed a huge employment boom around North Dakota's Bakken oil shale area that ripples out for hundreds of miles, while a Manhattan Institute study showed that U.S. counties that allow fracking perform much better economically than those that don't. The boost to the larger economy comes from lowering the price of natural gas and oil as both an energy source and an industrial input.
The big question on the agenda is whether the government should approve the export of liquefied natural gas. Countries without free trade agreements with the U.S. need licenses to purchase it. There are strategic reasons to allow export: allies Japan, India, and Turkey are among the eager buyers, and it would undercut gas-exporters Russia and Iran. There is opposition from some industries, but President Barack Obama spoke of aiding Central America with LNG exports on his trip to Costa Rica, and bipartisan momentum is building in Congress for expanding exports, so a favorable decision on some of the 19 non-FTA license applications is expected soon.
On the Horizon: The energy boom is here, now. A bit further out but also promising to give a forceful jolt to growth and productivity are impending technological breakthroughs in manufacturing processes, advanced materials, bio-tech, robotics, and artificial intelligence.
Trade: This year has already seen a flurry of efforts to forge new multilateral free trade agreements, most importantly bringing Japan into the Trans-Pacific Partnership talks and initiating negotiations for the Trans-Atlantic Trade & Investment Partnership. While QE has led to currency depreciation, only Japan has seen a sharp step-up in exports, and few can win if everyone seeks growth by trying to grab existing export markets. Broad trade expansion, on the other hand, can give global growth a boost because rising imports and exports foster productivity and efficiency. This more generous, non-mercantilist approach, along with the strategic benefits of commercial integration, appears to underlie the new initiatives.
Yet there is a risk to focusing on massive new FTAs: it takes the focus off the WTO. Although the WTO's negotiating function is in disarray due to the collapse of its Doha Round, the institution has been doggedly carrying out its vital function of enforcing global trade rules and can take some credit for the world not falling into a crisis-driven protectionist morass. Also, Washington may be leveraging its FTA activities to the WTO's advantage. By drawing in a broad array of countries but not including the Brazil-Russia-India-China-South Africa bloc, the BRICS may feel isolated and decide it is time to play what the U.S. would consider a more constructive role in the WTO. This dynamic is unlikely to un-block Doha in the near future, but it may pave the way for agreement on a smaller deal centered on trade facilitation that WTO members hope to have in place for their December Ministerial Conference. It could also ease BRICS opposition to the ongoing talks for a plurilateral WTO Trade in Services Agreement. The May 8 announcement that the 159 members have chosen by true consensus (no country was opposed) Brazilian trade negotiator Roberto Azevedo to be the next WTO director-general can only help consolidate BRICS and other developing-country support for a more vibrant WTO, which could make getting-to-growth more possible for the world economy.
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