Politics and History

The Washington consensus

By Business & Finance
03 October 2011
Capitol Hill

During a week in the US capital, John Walsh took in a wide range of views on the economy, US corporate tax and President Obama’s re-election prospects.

There is a pre-election buzz in Washington. It may seem but the blink of an eye since President Barack Obama’s historic win in November 2008, but elections in the US have much longer cycles in most other countries. Seven contenders are currently slugging it out in the Republican primaries. First prize is a tilt at the Democrat incumbent in 2012. Obama’s poll ratings point to a growing possibility that he could remain a one-term president. The sclerotic state of the economy is the cause of deep and widespread malaise. In particular, the unemployment rate which is stuck at a stubbornly high and problematic 9% level.

The stratospheric US fiscal deficit is usually only seen in wartime. But the political consensus that usually comes in a time of conflict is clearly absent on this occasion.
The emergence of the Tea Party, flanked to the right of the Republican party, has added a frisson to the coming election.

The televised debates between the Republican contenders have been characterised by the usual jousts and mutual recriminations that come when the stakes are high. But the almost febrile haranguing of the president by Tea Party favourites; Minnesotan Congresswoman Michele Bachmann and Texas Governor Rick Perry has added a new, and according to Democrats, darker dimension to the pre-election posturing.

Ambassador Elizabeth Bagley will play an important role in the re-election prospects of Barack Obama. The attorney and diplomat is a senior adviser to the Secretary of State and Chair of the Democratic National Committee and a prominent fundraiser for the party. When Business & Finance caught up with her at her Georgetown residence, her assistant apologised for a cleaning up operation that was still under way. A ‘special guest’ had come around for dinner the night before. That special guest turned out to be the president and the dinner was a $35,000 a plate fund raiser.

Unsurprisingly, Amb Bagley is not a fan of the Tea Party or what they represent. “I think they are anarchists more than anything else. You cannot run a country with anarchists. They say their hero is [former president Ronald] Reagan but he was a lot more moderate than people realised. When it comes down to it, they will not get their way. These people just don’t want a government.” She argues that the broader support for the Tea Party among the US electorate is limited because “the vast majority of Americans are moderate”. Nevertheless, the Tea Party’s pugnacious style has fed through to even moderate Republican candidates, which has had the effect of putting the president on the back foot.  Obama has never recaptured the electricity he generated on the campaign trail in the run-up to the 2008 election. Instead, he has appeared professorial and almost aloof. It couldn’t be more of a contrast to the last Democrat president Bill Clinton, who had a near telepathic connection with the electorate.

Amb Bagley acknowledges that Obama has hit a soft patch. “I think he now realises that he cannot bring Republicans along with him through his own measured reason. He is a very thoughtful person who thinks he can convince everybody to come along with him, but now he realises that the Republicans really do not want him to succeed.”

That is about to change, she adds. “I found him last night [at the fundraiser] to be much more aggressive. The criticism of him is that he is not a fighter and gives in too easily, but I think now he is showing that he is ready for the fight. He is taking his message to the people and reaching out and that is something that he doesn’t do naturally.”

Economy Inc

James Carville, Bill Clinton’s former senior strategist, is responsible for two of the most overused quotes of the past two decades. “It’s the economy, stupid” and “when I die, I want to come back as the bond market.” The latter has been deployed with alarming frequency over the past few years, with particular reference to the European debt crisis. The former any time there is an election. Anywhere.

But the reason for their enduring use is that both are as apposite now as when they were first coined prior to the 1992 US election. Government policy is more important now than anytime since the 1930s. Rising joblessness, declining incomes and an estimated 20% of US homeowners in negative equity is hardly the most propitious election backdrop for the incumbent.

In July of this year, the number of houses under construction was roughly 240,000, which was down from 280,000 the previous July and well down on the one million houses under construction in July 2006.

Usually when an economy experiences a precipitous decline in GDP similar to what happened in the US between 2008 and 2010, there is a sharp rebound.

Harvard and MIT-educated Donald Marron was a member of the President’s Council of Economic Advisers between 2008 and 2009; deputy director of the non-partisan congressional budget office between 2005 and 2008; and, between 2002 and 2004 he was chief economist for Congress’s Joint Economic Committee. He says that the US economy faces a long and slow recovery. “This time, it really is different. Some economists looked at previous recessions and saw a sharp rebound. There was a time just after the original Lehman’s crisis, when some economists looking at data from previous recessions, concluded that the same would happen on this occasion. But financial crises are different. The reality is that if you look at the history of financial crises around the world, it tells you that if you have a banking and economic crisis, then the economy will remain weak for a long time.”

There is a lot riding on the performance of the economy over the near to medium term. If it slips back into a double-dip recession, then it will weigh on Obama’s prospects for victory in 2012. Before the crisis, the US was the engine of the global economy. It soaked up two-thirds of world exports. If it remains in a prolonged slump, then growth in Europe and other OECD regions will remain anaemic.

But the US economy is in a double bind, explains Barry Bosworth, a former adviser to President Jimmy Carter and currently a senior fellow with the Washington-based think tank, the Brookings Institute. “Normally after a crisis like this, there is a currency devaluation which gives a boost to exports.” He says that the normal levers are not options for the US on the basis that the dollar is still overvalued on a trade weighted basis combined with structural problems with the US corporate sector. “US multinationals are in good health. Their balance sheets have never been stronger. But in the US, it is medium to small-sized companies that create employment. These firms don’t know how to export because they have never had to do it. They could always rely on a buoyant domestic economy.”

And even though there are risks of a global trade war breaking out, Bosworth says the G20 has done a very good job of preventing larger nations pursuing beggar-thy-neighbour competitive devaluations as a means of enhancing growth prospects. He doesn’t expect this solidarity to unravel  “because the world is too interdependent”.

Consequently, until such time as the US private sector fixes itself, recovery will remain stuttering and fragile.

To this end, a lot will hinge on government policy. Obama has unveiled the $480bn American Jobs Act with the aim of boosting the domestic economy in the near term. The plan calls for a $240bn cut in payroll taxes combined with a $140bn spend in infrastructure aimed at improving roads, bridges and schools. At the same time, the president is looking to cut $4,400bn from the budget over the next 10 years.

Democrats claim that the jobs act has the potential to create between one and two million jobs over the next couple of years.

Even Republicans concede that these are laudable aims.  But the two parties are implacably opposed as to how both targets should be achieved. Obama wants the deficit reduced through a combination of spending cuts and taxes on high earners, particularly those earning over $1mn a year. Moreover, Obama intends to pay for the American Jobs Act through closing off tax loopholes that benefit the wealthy, including the owners of corporate jets and hedge fund managers.

The Republicans are adamant that they will not support any bill that includes tax increases. They propose to stimulate the economy by rolling out further tax incentives to businesses.  Even though Bosworth is more sympathetic to the President’s position, he sees little chance of the American Jobs Act passing through Congress. “Most economists will tell you that the Republican’s plan will not work. But this is not an argument that Obama is going to win.”

He argues that the Obama administration made the fundamental error in 2009 of thinking that this downturn was part of a normal business cycle. “They took their eye off the economy too soon after the fiscal stimulus package in 2009 and turned their attention to issues like Medicare. The problem now is that the public will only tolerate large fiscal imbalances in times of war. That makes things really complicated now in terms of how we are going to deal with this crisis.”

Even though Marron is a budget hawk, he says that there is a strong case to be made for the stimulus package. “The interest rate is close to zero and as a result there is no risk the [US Federal Reserve] Fed will do anything to risk a stimulus that will come from fiscal policy. If there was ever a time to do this package, it is now.

“I am certainly not a pro-debt sort of person. I think we need to bring the debt in over the long run, otherwise we will end up with serious structural problems. But my sense is that the downside risks [to this stimulus package] are low.”

The US economy came close to defaulting in early August following a game of tense brinkmanship between Democrats and Republicans on agreeing deficit reduction measures before either side would agree to raise the debt ceiling.  As a consequence, a bi-partisan debt reduction super committee was formed comprising senior figures from both parties, including Senator John Kerry.  Recommendations from this committee can be expedited through Congress. Marron says there is a chance the American Jobs Act could get passed through this route.

Amb Bagley disagrees with Bosworth that the president took his eye off the economy in 2009. She says he had made a number of commitments during the campaign that he had to honour. Moreover, the $787bn package negotiated that year was the biggest in the economy’s history “It was bigger in real terms than [Franklin Roosevelts] FDR’s new deal.

Maybe it should have been bigger but nobody realised how bad the economy was. But the political will was just not there to get anything bigger.” What’s more, she is bullish about his prospects of pushing through the American Jobs Act and getting re-elected. “The president is taking his message to the people. He is going to Boehner’s and Cantor’s districts and reaching out. I think people are responding and I think they will be pushing their representatives to reach some sort of an agreement. Boehner and Cantor can’t keep denying the president forever. I don’t think the super committee will get $4trn in savings, but I think he will get $2trn.”

Republican John Boehner is the speaker in the Congress and Eric Cantor is the Republican House Majority Leader in the Congress. Amb Bagley is also convinced that the president will get re-elected. “It is hard to defeat an incumbent. It is not that people dislike Obama, they just want more leadership and he is showing that now.”

She favours a run against Governor Rick Perry from Texas. “Perry is a cowboy and will be easier to run against. Most Americans are moderate and would be afraid of him.”

Corporate tax rate: Repatriated profits ‘must be ploughed back into US jobs’

The amount of corporate tax US companies pay has become a big issue. Michele Bachmann recently called for the ‘repatriation’ of the 100,000 jobs created in Ireland by 600 US multinationals. It is one of the few – possibly the only issue – that finds common ground between Democrats and Republicans. President Obama came into office promising to reform the corporate tax system. One of the favoured options is to look at the system of deferral. US multinationals are greatly reducing their US tax obligations by channelling their profits through lower rate destinations abroad. Ireland has come in for heavy criticism in this respect. The system of deferral would mean that companies would now have to pay the difference between the lower rate they pay in another jurisdiction and the standard 35% rate that applies in the US.

Ambassador Bagley says that loopholes in the US corporate tax system have to be closed. “As much as I love Ireland, it is outrageous that companies like GE can go to Ireland or other countries and not pay taxes in the US – and they don’t bring in any jobs. These corporations have the same rights and advantages as US citizens but they do not bring in any jobs.”

Jeff Immelt, CEO of GE is chairman of President Obama’s Council on Jobs and Competitiveness. Last year, GE announced that it was relocating one of its divisions from Wisconsin to China. Amb Bagley is critical of Immelt’s appointment. “Jeff Immelt as head of the jobs council is a particular problem. It gets to be a bit of a problem when you do not practise what you preach. We need to make it more attractive for US companies to come back.”

Donal Marron (pictured) is more circumspect about reforming the US corporate tax deferral system.“This proposal was something that was tried before. Analysts went out and studied the impact – and to the extent that you could track through the money, the universal finding was that there was no effect on US economic activity. Money is fungible. The US government says that this extra capital will create new jobs, but these corporations already have enough money to tick that box. Based on that, most economists I know are sceptical about another round of repatriation as a form of stimulus.”

Marron argues that the only way to overcome the fungibility issue is by passing legislation that enforces US corporates to plough repatriated profits into job creation in the US.

Amb Bagley says that legislation in this area could be passed as part of the American Jobs Act.

New treaty please: Without organised fiscal federalism, the euro is ‘doomed’

The internationally-renowned Peterson Institute for International Economics stands on Massachusetts Avenue close to where the many government buildings in Washington. However, Nicolas Veron, who is a fellow at the institute, has his mind focused on problems on the other side of the Atlantic.

He says that unless a new EU treaty is introduced then the single currency is doomed. Moreover, the new treaty will need the same heft as the Maastricht Treaty, argues Veron. “The new treaty will have to be bigger than anything since Maastricht because Lisbon, Amsterdam and Nice were just changes to the decision-making framework. They were not major changes in what the EU does.”

There has to be fiscal federalism as well as banking federalism if the euro is to survive, he adds. “We need fiscal federalism – we already have it, but it is not organised and it needs to be on a sustainable footing. We also need federal EU banking policy which does not exist yet despite the creation of the European Banking Authority. These two are needed to complement existing monetary federalism. This requires a new set of political arrangements to define what can be done at EU level.”

Moreover, Veron argues that new euro zone supranational institutions will have to be created that will take control of fiscal and banking issues in member states. Needless to say these reforms are likely to meet stiff resistance at a national level: “That is something that is very difficult politically. But I am not sure we have a choice if we want the euro to survive. The alternative is that the euro would not be able to survive the next stages of the crisis.”

The inflection point in the euro zone crisis came in July of this year when contagion spread to Italy. He says that if euro zone governments had grasped the opportunity in 2009 to reform and recapitalise the banking system across the region, then the crisis could have been resolved without a new treaty and changes to the institutional framework of the euro zone. “We could have gone for a Greek sovereign debt restructuring and we could have imposed haircuts on senior bondholders in Irish banks. But now that horse has bolted.”

Until such time as these changes can be introduced, the most effective stopgap measure would be to enable the ECB to extend credit lines to the European Financial Stability Facility [EFSF] in order to recapitalise the banking system, he says.

A serious challenge that faces the region are the tensions that will surface between euro zone members and non-euro zone members of the EU such as Britain, Sweden and Denmark. “We only have one EU parliament and one EU court. We do not have a separate parliament or court for the euro zone and it will not be possible to design separate institutions for the euro zone as this would require separate treaties and design mechanisms. But it is hard to see how these tensions will be managed. There are examples of asymmetrical federalism in places like Malaysia. I think this will be a huge issue down the line for countries like the UK and whether it decides to remain in or leave.”

Veron says that the German government has failed to take leadership of the crisis. “They sold a narrative to the electorate that blamed the crisis on Anglo-Saxon speculators and lazy southern Europeans. There has been nothing in this narrative about the role German banks played. But now this is a cause of great concern because when the German people find out they have been lied to about the causes of this crisis, it will not be a happy day for German leaders or the political system.”

But there are signs that senior German business people are now entering the debate, says Veron. Moreover, they carry a lot of political clout and they realise how much the country has to lose if the single currency were to unravel, he adds. “The good news is that the debate is making progress.”

Over the longer term, he warns that the euro zone faces difficult choices. “There will be a huge economic cost for not getting ahead of developments. I hope Europe can survive this crisis but it will certainly make us poorer as it has already done in Ireland.

“At a global level, it will accelerate the transition to a world where there is no difference between the developed world and emerging countries as the former get poorer and the latter get richer. There is something inexorable about this process.”