Monday, May 23, 2005

Time for Next New Deal

Tax cuts of more than trillion dollars over a decade has been the primary response of this Bush Administration for the economic challenges faced by the American society in last few years. Though it is one of the standard responses in recession times, the structure and distribution of this tax cut have been much skewed than what it could be for better economic impact. Other prominent policy actions of this administration include No Child Left Behind Act; expensive expansion of prescription drug benefits for elders under Medicare (unfortunately achieved by misleading Congress); stricter Bankruptcy control and limiting medical malpractice liability. Beyond all this extending these tax cuts permanently and basic changes in Social Security have been follow up policy initiatives of this administration. Based on this incoherent set of policy initiatives, it is difficult to describe them as a part of proactive Economic Policy. Conservative instincts of letting market forces drive the economy and not to disturb market mechanism is clearly at play. But may be it is the case that this administration is missing out on a thorough policy towards the economic challenges of America in coming decades.

It is quite natural for the Administration and supporters of President Bush to feel that the policy centered around tax cuts and doing nothing else is quite adequate. Vice President Cheney has gone on record to say that Regan rule has proven that deficits do not matter. Hence any critique of this economic policy based on deficits is not relevant for this administration. However it is well known and widely accepted economic wisdom that any deficit of more than 3% of GDP cannot be sustained for long without consequences. Administration is very likely to point out the reducing deficits in the month of April 2005 in support of it’s working policies. Employment generation of more 240K jobs in the month of April 2005 is yet another proof for the administration that it’s policy is working. But despite these encouraging news, this Administration itself points out the grave long term challenges of increasing Federal commitments on account of Medicare and Social Security. So it should be reasonable to argue that the recent trend, howsoever encouraging; does not automatically resolve the long term deficit challenge faced by America. On the job front, April 2005 has been one of the only few months of a recovering economy with reasonable job creation. Overall statistics is clear that the recovery in last few years has been with much less job creation than what is needed or what potential America holds for. It is also evident from the numbers that types of jobs created are not high paying jobs. On many occasions these jobs are insufficient to meet the basic living expenses. It is also in the numbers that Americans are increasingly loosing high paying jobs to other countries beyond the normal churn dictated by a market mechanism. ‘Be patient’ has been the mantra of this Administration for the larger population of America. However, considering that we are in the fourth year of recovery with a potential of again dipping into a recession; it is not out of the way for Labor to be cautious and skeptical of this tax cut oriented policy. Sustained deficits over a period are likely to increase interest rates at some point with big impacts on economically marginal sections of society besides many other repercussions.

The Capitalist dogma of the last century holds that a recession arises due to business cycles i.e. more supply than demand. The dogma says that invigorating demand is the key to get out of a recession. Tax cuts give the wherewithal for the populace to spend and thus to create the demand and this in turn helps to get out of a recession. The basic premise of this dogma is a national economy as a relatively closed system. Hence, tax cut induced more residue of money in the pockets of people finds it’s way in the increasing consumption – the consumption that is fulfilled by production capabilities within the closed system of the national economy. The tax cut residue also finds the way as investments in increasing the production within the closed system. Tax cuts may increase the deficits, but by printing more currency State takes over more debt and kick starts the recovery. In a way State is the only entity which can be outside the spell of market forces and that is what is fully exploited here. Inflationary pressure of increased notes printing is generally addressed due to the wider availability of labor pool during recessions. So there could be short periods of unemployment for workers but as long as demand increase takes place (apart from tax cuts, natural population increase is also one dominant reason); the economy would find a way out of a recession.

On this background the original New Deal addressed the question of what happens to workers after the active employment life i.e. in retirement. Since Business has to remain within the relative confinements of national boundaries, it would create the necessary jobs through out the active life of an employee. In a way Business depended on State to get the necessary supply of Labor. Due to this dependency, State could even ask Business to take care of some health care costs of workers during employment and some retirement cost in the form of pension. The health care costs have been relatively manageable till 1980s also helped Business not to fret about these costs. Granted, there have been tax incentives for Business to shoulder health care costs of Labor. But implicit to all this has been the expectation of a reasonable growth rate of health care costs. With that expectations Business took the bargain with the State. Similarly, Business agreed for some portions of pension costs also. All these contributions from the employer made the State to take responsibility of remaining costs of Labor – the retirement cost what is left after pension and health care costs during retirement. As long as national economies remained fairly understood as a closed system, this deal among State, Business and Labor appeared to be sustainable. Despite the thriving International Trade; large part of consumption and production were primarily determined within national economies. In other words this closed system of national economy made it possible for the State to push out some Labor related costs on the plate of Business and then the State covered the balance in the New Deal.

Things changed in the last decade. First, the health care costs started to increase at a higher rate than the expected rate. Since Business shouldered the main costs, the end consumer has been away from paying medical bills directly. The primary pressure of a consumer never got realized in such a system. Once the other vested interests (interests of Health Insurance companies and political clout of Pharmaceutical companies) got well entrenched in this separation of the end consumer and the provider; containing costs became secondary to passing the costs to other. This has resulted in a unmanageable mess. Suddenly, whatever State involvement has been there in footing the medical bill; it has increased dramatically in last few years. This is apart from making Businesses uncompetitive due to increased burden of health care costs. Second, the demographic shift towards reduced number of employed workers supporting large number of retired workers started to appear on horizon. The larger number of retired workers multiplied by increased retirement medical costs results as an enormous burden to Uncle Sam. There have been many estimates, up to one third of GDP, dedicated to health care costs in coming decades. Third thing as a consequence of this demographic shift is the well known issue of Social Security solvency which President Bush has been discussing for a while – lesser contributions from employed workers to support more retired workers. All these things suddenly make the State’s share of New Deal bargain much more expensive than what it looked earlier. The increase is so much as to generate a doubt whether Uncle Sam ever will be able to fulfill the commitments under the existing New Deal.

One response from Democrats or Liberals has been to eliminate Tax Cuts so that State gets more money to address these increased commitments. But it flies against the dogma of Capitalism of the last century – without Tax Cuts how do you pull the economy out of a recession? Argument from Left is have Tax Cuts well targeted with wider distribution; contain other expenses of State and voila – you get all the money you need without compromising the economic stimulus. This would also reduce risks to Economy due to a higher deficit.

One can side with this Liberal argument as long as the perceived increase in State’s commitment for retired Labor is indeed what it is. What if there is more to come than what has been estimated by the three new developments discussed earlier? The assumption is Business here would continue to hold it’s share of bargain. And that is where the real challenge of the 21st century is. National economies are no more closed systems. Meaning Business can fulfill demands generated in one economy without at all undertaking production in that national economy. With the advent of “Flat World” as Thomas Friedman calls; anything which can be digitized will be done anywhere in the world. Naturally, Business locates production where costs are lowest. So the whole scenario of Tax cuts stimulating demand which is turn increases the production which in turn increases the employment no more holds. So then what happens with Tax Cuts? Nothing much apart from increasing the deficit for State. Also if these Tax Cuts are as skewed and tilted towards rich as the present Bush Tax Cuts are; it simply increases the inequality within the society. It is not the issue of Business to worry about the inequality within a society. That is the job and mandate for State to address. If large sections of population are left out of participation in the economy, the tendency towards restricting import of outside produced goods and services would increase. This would result in Protectionism, bringing in the full contradiction for the Capitalist State like America which has been all along the main bull work of International Trade and Global Economy.

Apart from keeping the promises of the New Deal; suddenly the State needs to worry about the potentially increasing inequality. Leaving aside the increasing eventual risk of abrupt changes to Business due such inequality (you mean class warfare or riots in America?), it is a moral issue for State to address. Unless the State makes a U-turn about the Trade Policy; this is one more item on the plate of the State. It does not stop there. Due to flattening of the world at once State is at loss with Business, especially the Globally present Business, in terms of where to locate the production. State can no longer be assured that thriving Business means increased production (goods or services) within the national borders solving it’s problem of employment for it’s Labor. That is no more assured. Mightiest of all States – Federal Government of USA – also needs to compete with many other national economies for wooing Businesses to locate production within it’s borders. This is new to Uncle Sam. All of a sudden the whole leverage which Uncle Sam had with Business to solve it’s employment problem is gone. One of the strongest rule of law in the world, the best possible security in the world, the top rated business regulations in the world; all these America’s advantages suddenly are not enough to entice Business to employee more people in America. Cost emerges as the strong repellent. The American State looses the bargain power with Business. This results in more cost getting eventually pushed to the State. Whatever pension and 401K costs Business has been covering; it will not like to cover those going forward. It is a matter of time before all businesses follow the footsteps of United Airlines in pushing the burden of pension to Uncle Sam. Further, at best businesses would like to shoulder a fix cost of employee health care; not an open ended privilege. Business would prefer to restrict it’s commitment only to some limited contribution amount leaving an individual employee to bother about paying soaring medical bills in entirety. This way the headache of medical care cost inflation is left to an employee and her State to sort out, not to the Business.

It is a delusion that this additional load of costs pushed to State in coming days can be avoided. Unless we come up with an alternative to the present Global Trade based Global Economy; there is no avoidance to this increase of cost to the American State. In response the State can push some of the increased burden to individuals. It does not have to be privatization of Social Security, but it can be limiting State’s exposure as far as retirement commitment is considered and putting structures in place so that individuals are encouraged to save for their retirements. Attempts to bring an individual consumer to the center to help tackle the costs is essentially the challenge in coming days. There is no way the present day America can keep on attracting businesses to generate employment in USA when qualified workers of other countries do not impose any hefty health care costs and expensive pension contributions.

Does this mean a sell out to Global Business? Not necessarily. One area where State can have a leverage is to make Business share the cost of creating usable new Knowledge – all new Science and Technology which State funds. It is not going to be free any where in the world. Why would Business not pay part of it when it knows how profitable R & D results can be. Traditionally, lot of profitable goods and services are created by businesses based on public financed R & D. Prime example is Pharmaceutical Industry basing it’s profit on mainly public financed research. In the 21st century, it is questionable how much such free Knowledge Business can get from State. On the other hand, State’s problem becomes how can it ensure more and more of it’s citizens are able to participate in this Knowledge Economy. For Economy like USA, it is all the more important. Because, even if State and Labor shoulder the cost of active employment health care and all of retirement; production is unlikely to be competitive in USA compared to many countries. The story of the first half of 21st century is large parts of the world getting developed (read China and India). For really long, long period there are going to be large pools of workers with ultra low costs compared to USA. This means the only realistic opportunity of employment within countries like USA will be in Knowledge creation Business (leaving aside services like local goods distribution, restaurants and schools). High costs of Knowledge creating workers still do not give the option of letting the health care costs and others costs to remain with Business - simply due to the intense competition all over the world to attract these Knowledge Industries. So in order to address the problem of educating citizens of America so as they are able to participate in Knowledge Economy more and more; the State would need to fund more Higher Education of workers apart from elementary schools. Part of funds for this larger participation in Higher Education could come from Business. At that point all the traditional advantages of an excellent rule of law, the best security in the world, the best business regulatory framework and world class highly educated labor pool along with much less collateral costs would make it irresistible for the Global Business not to choose America.

The New Deal of 21st Century needs to adjust to this new reality – Labor taking some of the more traditional responsibilities from the State in lieu of getting more avenues of Higher Education, the State providing at least part of health care costs during unemployment and combined (State and Labor together) handling of retirement. More tax cuts is a mere doctrinaire response from the Bush Administration. Traditional Conservative response simply looks at only one dimension of the bargain with Business and forgets the root reason why State engages with Business in the first place – to solve it’s problem of employment. The New Deal for the 21st century means a different arrangement, not the abrogation of responsibility to provide employment. Democrats are naturally disposed to take this challenge. But again they cannot as well address it in an ideologically blind way. It is imperative to realize how much leverage State has lost against Global Business in this new Flat World.



Umesh Patil
May 23, 2005
San Jose, CA 95111.

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