Educating Thomas Friedman on the Economy

June 06, 2012

It’s a tough job, but someone’s got to do it. Today, Thomas Friedman tells us about the squandered opportunities around the world.

Someone else can straighten him out on China and the Arab world (the U.S. government’s fondness for hereditary monarchies and autocratic regimes clearly is part of this story), but I’ll pick up Europe and the United States. In the case of the former, Friedman joins German Chancellor Angela Merkel in lecturing the peripheral countries on their failure to take advantage of low interest rates in the last decade to modernize their economies.

While there is considerable truth to the complaint about the failure to modernize their economies, there is an important piece missing in the chain of causation here. The housing bubbles in Spain and Ireland and the excessive spending in Greece were financed by banks in the core countries, most notably Germany.

While these banks were happy to finance endless construction projects in Spain, it is not clear that they would have been willing to also put up money to support improved education or modernized infrastructure. The decision of banks in Germany to finance certain paths of development and not others helped push the peripheral countries to follow those paths. In short, the governments in the peripheral countries deserve considerable blame, but the banks in the core countries were essential enablers who pushed them down this path.

In the case of the United States, Friedman complains that:

“in the 1990s we enjoyed a peace dividend, a dot-com dividend and a low-oil-price dividend, which combined to sharply reduce the federal deficit. But 9/11, two wars accompanied by tax cuts, not tax increases, a Medicare prescription drug plan and a necessary bailout to prevent a potential depression put us more in debt than ever.”

Well, this is not exactly right. The main reason for the shift from large surpluses to large deficits was the collapse of the stock bubble in 2000-2002. This sharply lowered revenue and threw the economy into a recession in 2001. However badly designed the Medicare drug benefit was (in order to boost the profits of the drug and insurance industries), it did make drugs affordable for millions of seniors and it did not cost all that much money.

The bailout was actually not necessary to prevent a depression. Argentina had a complete collapse of its financial system and then fully made up the lost ground in 1.5 years. Presumably Ben Bernanke, Timothy Geithner and the rest are not too much less competent than Argentina’s economic leaders.

Furthermore, the main reason for the large deficits at present is simply that the economy is far below its potential level of output. In the short-term, this can be met with increased government stimulus (yes, that means larger deficits). In the longer term, we will have to get the dollar down to make our goods more competitive internationally, thereby reducing our trade deficit.

Since Friedman gets the analysis wrong, he naturally gets the prescription wrong, telling readers:

“Getting healthy again will be wrenching for all of us. If I were President Obama, I’d focus my entire campaign now on an effort to reforge a ‘grand bargain’ with Republicans based on a near-term infrastructure stimulus tied with a Simpson-Bowles long-term fiscal rebalancing. At a minimum, it would show that Obama has a sensible plan to fix the economy — which is what people want most from the president — and many in business would surely support it” (emphasis in original).

Actually, getting healthy again will not be wrenching for all of us. The key to getting healthy for Europe and the United States is to spend more money to boost the economy. In the case of Europe, the European Central Bank will have to give up its obsession with its Maginot Line (its 2.0 percent inflation target) and will instead have to act like a central bank. This means guaranteeing the bonds of debt-burdened countries like Spain and Italy. Learning economics may be a wrenching experience for policymakers, but the movement from severe underemployment to something resembling full employment will not be wrenching at all for the rest of us.

As far as Freidman’s preferred solution for the United States, the deficit reduction proposal put forward by former Senator Alan Simpson and former Morgan Stanley director Erskine Bowles, it is neither sensible nor “what people want from the president” (italicized or not). This proposal includes large tax cuts for the very wealthy. Most of its deficit reduction comes from reducing Medicare and Social Security benefits.

The latter is highly unpopular among people across the political spectrum. It is also not good policy in a context where most retirees are already struggling to get by. Few near retirees have defined benefit pensions. Nor do they have substantial savings in defined contribution accounts and they have lost much of their home equity as a result of the collapse of the housing bubble. This means that they will be almost entirely dependent on Social Security and Medicare in retirement.

A far more reasonable solution of the country’s projected long-term budget problem would be to address its source, our broken private health care system. If our per-person health care costs were comparable to those in other wealthy countries we would be looking at huge budget surpluses, not deficits. Fixing the health care system means going after powerful interest groups, like the pharmaceutical industry, the insurance industry, and highly paid medical specialists, but there is no way around this battle if our economy is to remain healthy in the long-run. 

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