US Economy – Muscular or Obese?

The US, with great potential for economic growth, still could rescue the dragging global economy – the country’s energy development, agricultural output, steady labor force, and education programs all offer promise. But the US has immediate challenges, argues economist David Dapice, including rising inequality and high youth unemployment rates. Young workers often bring innovations to workplaces, and without them, quality and skills of the labor force could suffer. Inequality, lopsided government spending and heavy borrowing, and delayed infrastructure maintenance pit rich against poor and young against old. Politicians fail to enact regulations or reforms, spurred by a few wealthy industries and political donors willing to invest millions to pursue their narrow interests. There are no easy fixes. Plans from extreme ends of the US political spectrum – severe spending cuts or taxing the rich – won’t solve these problems. Responsibility for instigating tax and other reforms rests with US voters. So far, the electorate and their representatives seem weary and overwhelmed, giving little thought to the future. – YaleGlobal

US Economy – Muscular or Obese?

The US could revive the global economy, but tax reform is urgently needed
David Dapice
Thursday, August 16, 2012

Rainy-day audit: Tough times are prompting US voters to question policies and a tax code that contribute to rising debt, inequality and polarization

MEDFORD: As dark clouds gather over Europe and growth in the BRIC’s slow, the world once again looks to the old steady engine of growth – the US. Some analysts are even finding new sources of strength for the US economy to rebound and presumably save the world. While the US certainly possesses tools to revitalize its economy in the long run, it faces serious challenges in the short term. The US may not be ready to save the day at this point in history.

 With election negativity emphasizing current weakness in the US economy, contrarians are arguing for an optimistic view of US reinvention and renewal. Sure, unemployment is high and GDP growth sluggish; wage growth low, pension and medical costs threatening public budgets; and China is surging past the US in terms of total output. But there are many positives: Shale gas and oil promise energy security. Food production, droughts aside, is strong in a world that demands more. Educational institutions that attract students from all over the world combine with venture capital in an open society that creates the likes of Google, Apple, Microsoft and Facebook as well as Boeing, Caterpillar, IBM and GE. A combination of a weak dollar, rising Chinese wages and tame wage growth in the US has led to a manufacturing revival. US banks have written off more bad loans than their EU counterparts and bulked up on capital. Demographics favor the US – a combination of birthrates at replacement level and migration mean that the work force, and thus total output, will help cover elderly benefits. In contrast, labor forces will shrink in the EU, Japan, Russia and China. In short, it is argued, the US economic outlook is good.

In any discussion like this, it’s useful to assess short- to medium-term issues as well as longer term problems and opportunities. For example, it’s true that the labor force will grow in the US, though at a slower rate than in the recent past. However, college and high-school completion rates are not rising and may even fall a bit. In addition, high youth unemployment and poor “starter” jobs often lead to long- term impediments to lifetime earnings. If the US remains stuck several years with high youth and total unemployment rates, the quality and skills of the labor force will suffer. Potential workers may abandon the labor force, perhaps retiring earlier and taking low social-security payments.

Another concern is high inequality. The top tenth of the population has nearly half of all income and 90 percent of financial wealth. These are near all-time highs. Tax policy has been set so that the share of income paid in taxes overall and especially for the wealthy is near post–World War II lows. Indeed, the very wealthy sometimes pay a lower tax rate than middle-class workers due to a tax code that assesses capital gains and dividends at a lower rate than earnings, though on average the wealthy pay more. This inequality is reflected in lower generational income mobility in the US than in Canada or the UK: A person born into the bottom fifth of households sorted by income is likely to stay there, or perhaps bumping up to the next fifth. Likewise, a child lucky to be born in the top fifth is likely to stay there or fall only to the next highest fifth.  Such stickiness means that many bright people can’t develop their talents. Both they and the entire economy suffer.

Indeed, even this tilt does not fully indicate just how lopsided society has become. The biggest gains are not going to the top 10 percent but to a group within the top 1 percent.  Data show the share of income for the top 1 percent rose from around 10 percent several decades ago to nearly a quarter of income in recent years. That is, almost all of the gain in income share of the top tenth has gone to those within the top 1 percent. A super-concentration of income is also reflected in lopsided political contributions – if including the political action committees known as Super PACs, with unlimited donations from the wealthiest citizens, many with narrow and highly targeted interests. Republican and conservative campaign coffers are bursting compared to the skimpy size of the Democrats’ kitty.

This is the context in which America’s admitted and obvious problems must be solved. State, local and federal levels of government have promised far more than they can pay out. Total costs of pensions and medical support for Medicare and Medicaid programs will, on current trends, absorb total taxes in a decade or two. Some local governments have declared bankruptcy, and others are imposing harsh cuts in wages and hiring levels. While higher revenues are part of the necessary solution – total taxes have declined by 4 percent of GDP since 2000 – new ways must be found to pay for health and renegotiation of many pension benefits will be required. Massachusetts, the state model for universal health care developed by the Obama administration, is experimenting with fixed per-capita payments to health maintenance organizations rather than pay for procedures.

Pessimists point to a battle not just between rich and the poor, but also between young and the old. It would be unseemly and inefficient for the old to take a disproportionate share of resources that could go to education and other services that invest in the future. If infrastructure is also starved, all would suffer.  The American Society of Civil Engineers gives the nation’s overall infrastructure a “D” grade and estimates it would cost more than $2200 billion to bring roads, bridges, ports,  water systems and airports up to standard. This is more than total investment each year, though repairs could be scheduled over several years. In the meantime, costs of congestion, breakdowns, accidents and vehicle damage cost hundreds of billions of dollars a year. Not just money is stuck; organization and procedures are also arthritic.

Higher user fees and taxes, better efficiency in repair and use, and streamlined procedures for new construction would solve or ameliorate many infrastructure problems. Yet something as basic as storing nuclear waste is emblematic of a stuck system. Nuclear waste, more than 70,000 tons, sits in pools or dry casks around the country, waiting for $24 billion already collected to deliver a permanent site. The new air control system has gone well over budget and is many years behind schedule. With growing air traffic, the 1950s system in place risks being overwhelmed, but part of the new system, supposed to be installed in 2010, may not be operational until 2015. The financial infrastructure is another example of both private and regulatory failure, with heavy lobbying paralyzing attempts to limit risk and fraud.

So, the US economy has potential to rebound, but the ability to tap this potential is uncertain. Aside from the Erskine-Bowles deficit reduction plan, which received little support from either party or presidential candidate, there is no serious discussion of how to proceed on necessary, painful, efficient and fair tax increases and spending cuts. Both are needed, along with a sense of purpose and urgency. Neither Tea Party fundamentalism nor plans to target a few rich will solve the problems facing the US.


David  Dapice is associate professor of economics at Tufts University and the economist of the Vietnam Program at Harvard University’s Kennedy School of Government.

Copyright © 2012 Yale Center for the Study of Globalization