Sunday 22 June 2008

"Yes we can" or "No, we can't afford it?"

A number of articles has come out in recent weeks challenging the financial plans of the Democratic and Republican candidates for President. I'm glad to see this is finally getting some mainstream attention, because much of their platform appears divorced from the reality of the longer-term, structural problems affecting the economy.

Let's looks at some of these articles:

Paul Krugman's Op-Ed piece in the June 16th New York Times Fiscal Poison Pill looks at the Tax Policy Center's analysis of the two candidate's tax platform, and comes to the conclusion that $ 700 billion in added revenue over the next 10 years won't be enough to introduce universal healthcare.

The Economist ran an article entitled The battle of the pockets is joined in the June 14th edition quoting the same report. It offers a starker conclusion on the proposals: "The figures are debatable, but there is one clear difference. Mr. Obama's plan would redistribute cash to lower- and middle-income Americans, while Mr. McCain's would skew benefits towards the wealthy. That's something voters may find it easy to take a view on."

Lori Montgomery wrote a cogent article in the Washintgon Post entitled Big Promises Bump Into Budget Realities which offered a pointed reminder that even if the projections are correct, the rising deficit and total public debt will make major reforms difficult to implement. As she writes: "Good luck. Because, back in Washington, tax collections are slowing, the budget deficit is rising, and the national debt is approaching $10 trillion. Whoever wins the White House this fall, fiscal experts say, is likely to have a tough time enacting expensive new initiatives, be they tax cuts or health care reform."

All three articles are excellent and deserve attention. Yet I can't help thinking that we continue to look at very short term effects. We know that in the global market, the United States is facing declining manufacturing and service sector competitiveness, at least in relative terms. Why is offshoring taking place? Because it's cheaper and more effective to run insurance processing in Bangalore, India, or manufacture clothes in Zheijiang, China. That's also why the United States has a massive deficit in international trade in merchandise. Although the declining dollar will help manufactured product exports in the short term, this is a cyclical factor which betrays the longer-term decline in the American economy and public finance, and is not a welcome event.

We know that in terms of educational standards and attainment, the situation continues to be challenging, to say the least. The 2006 PISA study on educational performance shows that the United States scores significantly below other OECD countries in science knowledge at the secondary level. In higher education, the continually rising costs of a university degree are a major barrier to educational achievement. The tremendous regional variation in educational achievement and the method of financing public education at the state level (which relies extensively on property taxes in many areas) is a generator of inequality: rich neighbourhoods have rich schools; poor neighbourhoods have poor schools.

We know that the US is a very litigious society. The legal costs of doing business for companies and individual entrepreneurs continues to rise. One contact, a fund manager for a German investment firm, told me that he would not consider any investment in the United States below $ 10 million in value, because the legal compliance and due diligence costs were too high. Legal costs in certain sectors, such as healthcare, are a major driver not only of overall costs, but in corporate policy on providing treatment to certain categories of patients.

And finally, we know that the US may look like a single market, but the patchwork of state taxes, payroll taxes and federal taxes, as well as hundreds if not thousands of tax loopholes and special provisions, complicate the situation still further.

Yet if we look at the policy platforms of both candidates, we see a range of hollow promises which treat the symptoms, not the root causes of these problems:

a. "Tax reform" is usually code for tax breaks to supporters, rather than an objective look at international tax competitiveness and, more relevant, how tax income is used, and whether it is efficient or not. Right now, it is clearly not efficient, judging from the huge industry of accountants and offshore companies that exists to help Americans avoid taxes, sorry, I meant to say "file tax returns."

b. To reform the education system, we need a commitment on an objective measure for school funding (usually per student enrolled) as well as operating costs per location (a school in Manhattan costs more than a school in Duluth), and a system of getting that funding to the school. We need to remove property taxes from the equation, and ensure that in public education, every community receives the funding needed. The only way to do this is in the short term is to expand the role of Federal funding for primary, secondary and tertiary education. At present, the Federal allocation for education is $ 68.6 billion per year, which is only a fraction of state spending. Over the long term, the public funding system will need a paradigm change rather than short-term tinkering. Such a system change is possible over a 4-year administration (which is needed simply to build consensus and credibility), but then will require 10-15 years to implement. This must be a nonpartisan priority, because it is literally the future of the country. The Department of Education has made some good policy choices in this area, but funding for education must be increased, at least for the less well-resourced schools and universities - if results are to be seen.

c. Some type of legal liability cap needs to be introduced, although I am not at all aware of what this should be. Clearly, this conflicts with a range of Constitutional rights. On the other hand, the situation today is a parody of what a legal system should look like. Proposals on legal reform often hinge around (that is, founder) the ability of lawyers to contribute to political candidates, which shows you how broken the system has become.

d. In terms of manufacturing and general economic competitiveness, we have a big problems. America signed on to NAFTA and GATT (the precursor to the WTO) thinking that it's economic advantage would last into the future. Since then, competition has increased to unimaginable levels. South Korea, Japan, China - even Mexico and Canada - are now better manufacturers than the United States in key areas. In the last 10 years, US manufacturing has made quantum shifts in effectiveness: using lean manufacturing, automation and ERP systems, productivity is up and its share of GDP has remained important. However, it is losing competitiveness in two areas:

- Low value merchandise products, particularly those where high labour customisation is needed. The main factors here are vast manufacturing capacities established in China, Taiwan, and other countries.

- Higher-value products, where competitors are mastering the production value chain, and establishing dominance in key areas such as semi-conductors, consumer electronics, appliances and the automotive sector.

The situation is mixed, because part of the US merchandise deficit is attributed to US companies who are manufacturing offshore, and exporting to the United States. On the other hand, if we look at what's going on in China, South Korea, Taiwan and other powerhouses, it's clear that this is turning into a very one-sided race. The trade picture is complicated by the fact that at present, the US is leading in terms of complex, high value products, such as Boeing jets or General Dynamics vehicles. How long can this last?

We urgently need a long-term manufacturing scenario, a strategy/policy and real resources allocated to competitiveness. I don't mean necessarily mean subsidies, which I think in some cases would only worsen the situation. But we need to provide a competitive framework in the United States which makes it more profitable to produce (and employ) at home rather than export jobs, capacity and competencies. This is obviously a very complex area, and I don't have all the solutions ready to pull out of a hat.

Yet neither candidate mentions manufacturing competitiveness. There's a lot on trade competitiveness, but it's all about symptoms, not addressing the causes of the decline.

As I've said before, we should not be surprised if Barack Obama is not able to deliver what he has promised. This doesn't mean we shouldn't vote for him, but we do need to be aware of the painful economic reality that transcends political dogma and will be with us whoever wins the November 4th election.

1 comment:

  1. Hey, interesting post here too Phillip (good lunchtime reading at work here!).

    What are "General Dynamics vehicles" by the way?

    I've been working in education policy (STEM specifically--science, technology, engineering and math), and so it's neat to see your thoughts on educ. That bit about property taxes and the inherent inequality that public school revenue system brings def. makes sense. You'll have to check out the blog i've been writing for my job:

    I am actually moving on from the job Thurs. though, so what you see will probably be my last posts. But i've tried to organize it well and so if you're interested in STEM ed. it should be pretty straightforward to read up on some interesting stuff of recent (though we don't have comments allowed at this point). Here's a few you might be interested in:

    -a bill introduced by Obama and another Congressman on reorganizing STEM ed. at the Fed level:
    -a piece on Bill Gates' recent visit to Capitol Hill where STEM ed was a major topic:
    -one on a bill that would require national standards (though it was intro'd a while ago and may not go anywhere):