The 10 most important American economic policy issues of 2010

Here is my view of the 10 most important American economic policy issues of 2010.

1.  The weak U.S. macroeconomy

In 2010 a weak macroeconomy once again swamped in importance all other economic policy issues.  Forecasters had predicted a tough year — the 9.7% average unemployment rate for the first 11 months of the year is not far above the Administration’s 9.3% forecast for the year.

In 2011 the most important metric will once again be the unemployment rate.  Economically as well as politically the focus will once again be almost entirely on job creation.  We need the economy to be generating hundreds of thousands of net new jobs each month.  That is unlikely but not impossible.

Most forecasters project a stronger U.S. economic growth path in 2011 than 2010, but few are projecting that growth will be robust enough to bring the unemployment rate down rapidly.  While this week’s unemployment claims took a turn for the better, that’s a volatile data set, and the labor picture over the past few months has been weak.  If the forecasts hold up, things will be bad but improving throughout 2011.  You decide whether the politics and press will focus on the bad or the improving part.

Please remember not to lean too heavily on economic projections.  My rule of thumb is that the best macroeconomic forecasts get unreliable six months out and are not much more than guesses beyond a year.

2.  The failure of fiscal stimulus

This trend began in 2009 and solidified in 2010.  The fiscal stimulus debate camps and arguments are well established, and because the debate relies on comparison to a counterfactual it may never be provably resolved, allowing economists to argue ad nauseam.

Whatever your view on the policy question, as a political matter the stimulus failed miserably.  There are a few easily identifiable errors.

  • The President repeatedly took too optimistic of a tone relative to what his experts projected on something that was largely beyond his control.
  • Team Obama gambled and lost by creating an unverifiable “jobs saved or lost” metric.  Sometimes the unverifiability worked for them, but ultimately it broke against them because a job saved by policy is neither provable nor visible.
  • The policy path the President chose in early 2009 (more accurately, the path to which he acquiesced when Congress chose it) set up countless “waste, fraud, and inefficiency” stories throughout 2010.
  • After February 2009, every time the President signed another bill “to create jobs,” he reinforced the message that his first stimulus law was failing or at best insufficient.

3.  The stimulus vs. austerity debate

The U.S. is now left of Germany and the U.K. on fiscal policy in rhetoric if not result.  That is both weird and disturbing.

4.  (Temporary?) enactment of the health care laws

The President and his allies had a huge policy victory here.  I think these laws are an unmitigated disaster, the largest economic policy mistake in a long time.  The President and his allies created a massive new entitlement, spent budget offsets needed to address our long-term spending problem and therefore made future middle class tax increases a near certainty, and turned health insurance into a regulated utility.

The ongoing pushback from Republicans, even after enactment, was a wonderful surprise from a party that had for too long been afraid to debate health policy.  Democrats had to delay implementation of the most expensive provisions for a few years, allowing Republicans time to mount a repeal campaign that continues to build steam.  My first big blog mistake of the year was prematurely declaring the legislation dead after Scott Brown’s surprise victory in Massachusetts.  My second (unpublished) mistake was assuming that the President’s signature was the endgame.  It appears the 2012 Presidential election will be in part a referendum on these laws.

5.  Enactment of financial services reform (Dodd-Frank)

This is another big policy win from the Administration’s perspective.  I have mixed feelings on the law.  Some parts (like creating resolution authority for regulators to shut down too-big-to-fail firms) are essential, others (like the Consumer Financial Protection Bureau) are harmful, and still others (like the long-term resolution of Fannie Mae and Freddie Mac) are unresolved.

Many policymakers appear to have convinced themselves that new policies and structures are (or, in a few years when the regs are complete, will be) in place to prevent large institutions from failing.  I worry that we still don’t have a good solution for the next Black Swan event when (not if) one or more of those huge institutions do fail in spite of the new, better informed, and more powerful regulators.

6.  Carbon pricing implosion

In less than four years carbon pricing has gone from front burner to burnt toast.  The Climategate data fudging scandal undermined a previously strong positive public perception of climate scientists and their advocacy.  In Copenhagen the global negotiations imploded after confronting the problem of the China-India hole in the U.S./green strategy.  A Democratic House and Senate could not agree to carbon pricing legislation, demonstrating that regional economic perspectives are at least as important as policy philosophy.  The President walked a tightrope between demonstrating to greens that he was with them and allowing himself an exit strategy when legislation inevitably failed.  West Virginia Governor (and now Senator) Joe Manchin erased any doubt by literally shooting the Waxman-Markey bill in a campaign ad.

We now appear headed down the worst possible policy path.  Congress will not enact legislation but the Environmental Protection Agency will start regulating greenhouse gas emissions and allowing/encouraging States to do so.  This is the most economically burdensome way to regulate carbon emissions.  It will be large enough to impose significant constraints on domestic power production and heavy manufacturing now, and maybe on other sectors later.  Yet any reductions in U.S. emissions will be small relative to uncapped increases from China and India.  EPA’s rules and Congressional efforts to block them will create policy uncertainty, deterring needed investment in the expansion of U.S. power production and slowing long-term economic growth.  EPA’s regulatory authority always served two purposes to those who want to price carbon:  as a threat to try to force legislative action, and as a costly fallback if legislation failed.  The fallback option never made sense.  It should but probably won’t be abandoned.

7.  The Democratic Congress’ budget failures

From the perspective of Congressional Democrats, the health care and financial services victories counterbalance their two fiscal policy failures in 2010.  Tax rates on income and capital will not increase during President Obama’s first/only term.  They failed to enact full-year appropriations bills to fund the government, resorting instead to short-term continuing resolutions.  The new Congress will have to complete the leftover appropriations work in early 2011.  Many of the President’s spending goals will be unmet as he wrestles with a Republican House majority with very different priorities.  I am pleased with both outcomes, which exceeded my initial expectations.

Both results can be traced directly to decisions by Speaker Pelosi, Senate Majority Leader Reid, and their respective Budget, Tax, and Appropriations Chairmen.  They failed because they didn’t even try to govern.  They never tried to pass a budget resolution, they delayed action on taxes until the last possible minute when Republicans were strongest, and they never tried to pass appropriations bills in the Senate.  They missed an opportunity to create a reconciliation bill that would have allowed them (and the President) to win the tax extension debate.  In each case these were unforced errors by Democratic Congressional leaders that significantly affected the fiscal policy outcomes of 2010.

8.  Rise of the Tea Party

I have not much to add here other than to recognize that the small government impetus began with the early 2009 Santelli rant and exploded into summer 2009 Town Hall opposition to Obamacare.  I now think of it not as a political party, but instead as a strong and deep anti-TARP-autos-bailout-stimulus-Obamacare-cap-and-trade-government-spending-earmarks-deficits sentiment.  In simpler terms it’s a powerful populist pushback against the expansion of government.  Over the next two years Republicans can succeed to the extent they respect this sentiment and push for smaller government and a bigger private sector.

9.  Increasing awareness of medium-term fiscal problems

The bad news is America’s long-term fiscal problems are now medium-term fiscal problems.  The good news is that Americans are increasingly aware of those problems, and pressure is building on elected officials to solve them.  While nothing transformative on this front happened in 2010, several trends are important to note.

  • The shift from long-term to medium-term is a result of two factors: (1) inaction on entitlement spending over time by both parties; (2) enormous short-term deficits that are wiping out a projected temporary deficit trough before the Baby Boom spending wave hits.  Those enormous short-term deficits result from (1) the weak economy; (2) actions taken to recover from the weak economy; and (3) a generic expansion of government spending unrelated to economic stimulus.
  • In February the President’s budget launched this round of fiscal debate by intentionally leaving a large deficit hole to be plugged by recommendations from a new Presidential fiscal commission.  The President’s goals for that commission were too focused on the short run, and it’s unclear whether he intended the commission to solve the problem, provide him with cover for a proposal in early 2011, or just to buy him time through a mid-term election year.  Nevertheless, the commission reported in December with a bipartisan package of spending reforms and tax increases, teeing the issue up nicely for 2011.
  • Enormous 2009 and 2010 deficits and massive spending increases in those years raised the prominence of both the size of government and fiscal imbalance as important policy issues.
  • Fiscal crises in Europe and looming fiscal crises in various U.S. States focus attention on the U.S. federal fiscal problem.

It’s always safe to bet against a big painful fiscal policy change, but if it’s ever going to happen, 2011 seems like as good a year as any.  The 1997 budget deal was done by President Clinton, Speaker Gingrich, and Majority Leader Lott, a D-R-R alignment.  This time we have a D-R-D alignment.

10.  Round 2 of the Obama economic team

Three of the four key Obama economic advisor slots will be manned by different personnel in 2011 than a year earlier.

Out (voluntarily):  Larry Summers (NEC), Peter Orszag (Budget), and Christina Romer (CEA)

In:  Jack Lew (Budget), Austan Goolsbee (CEA), ??? (NEC)

  • The departure of WH COS Rahm Emanuel and upcoming departure of Senior Advisor David Axelrod will also have a big effect on economic (as well as other) policy.  My sources say they were heavily involved in almost all major economic decisions, sometimes operating as a separate decision-making layer between the economic team and the President.
  • Treasury Secretary Geithner and NEC Deputy Jason Furman are now the institutional memory of the Obama economic team.
  • Both Lew and Goolsbee are insiders who were promoted.
  • The President should have filled (or at least announced) Summers’ successor at NEC weeks ago.  The fall is policy development time in the White House, and the President hurt himself by not having in place a successor to his top White House economic advisor.

Have a Happy New Year.

(photo credit: Takras)

 

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