The United States economy is now entering its fifth year of underperformance, and with the unemployment rate stuck at 8 percent there is little prospect of change in the near future. What can be done to reinvigorate the economy and restore full-employment? The standard response of many economists is reflected in the call for greater fiscal stimulus and larger budget deficits. Yet, larger deficits hardly seem like a lasting answer to our economic problems. Added fiscal stimulus would initially lift production and employment, but at some date in the not too distant future that stimulus would have to be reversed, pulling the economy back down. To believe otherwise, one must believe that a tax cut or a new expenditure can somehow pay for itself, but the country fell for that supply-sider argument once and should not do so again.
It is important to recognize that the United States is no longer faced with a standard cyclical shortfall of demand, and the current gap between potential (full employment) output and GDP reflects deeper problems in the structure of aggregate demand. In the prior decade, the economy became overly focused on a binge of domestic consumption and excess homebuilding. All that collapsed in the 2008 recession. Housing demand will recover, but it will not and should not return to the bubble conditions of the mid-2000s. And, far from being weak, consumption is being supported at an unsustainable high share of GDP by large tax reductions and government transfers that have boosted household disposable income to an artificially high level. When those programs are scaled back, consumption will be a lower share of GDP. Furthermore, the nation cannot sustain its heavy foreign borrowing–importing far more than it exports. Hence, it is difficult to foresee a situation in which increased domestic demand can recover to the inflated levels that we associate with the spree of domestic spending in earlier years.
Instead, economic recovery will require the expansion of export markets and elimination of the remaining trade deficit. A renewed focus on exports will induce increased investment to expand capacity, and the rise in employment and incomes will leverage a higher level of consumption. Thus, the United States needs to concentrate on actions that will make it more competitive in global markets and an attractive place to produce and do business. It cannot afford to continue to see its most productive firms shift abroad. That means it needs a more skilled workforce, a better physical infrastructure, corporate tax rates closer to the average of its competitors, and the speedy development of shale gas as an inexpensive source relatively clean energy for both heat and electrical generation.
In past decades, the United States could justify its high wage rates with the argument the U.S. workforce was better educated and more productive than that of other countries. That is no longer the case. Other countries have caught-up and surpassed the U.S. performance, and younger generations of Americans rank near the average of OECD countries. Similarly, many studies suggest a significant deterioration in the public infrastructure. The United States has the highest corporate tax within the OECD and it exceeds the OECD average of 25 percent by more than 10 percentage points. In a world of increasingly mobile capital and technology, it should reexamine its position on corporate taxation, and sharply reduce the effective tax rate. The doubling of exports over a five-year period was an important aspect of the National Export Initiative that was announced by the Obama Administration at the beginning of 2010. Unfortunately, there has been little follow-through since its announcement and the goal is unlikely to be realized.