The economics and politics of the new economy

Usually I don't like Robert Reich's stuff. He tends to come out very strong on economic issues that are rather complex. Also he seems to attack economic policies from his political conscience. But he had a very good diagnosis of the political problems associated with present economic policy in the New York Times. Although I am not sure about his call for universal health care (though I could be convinced) his suggestions to cure what ails the economy are right on:

But if the insecurity keeps growing, and government keeps responding to it by trying to preserve jobs and spend pork, the economy will sink of its own dead weight. Future free-trade agreements will be impossible to pull off. The Pentagon and other agencies will be hamstrung. And our fiscal imbalances will swell to more grotesque levels. Yet what's the alternative? There's no returning to the stable jobs and steady wages of the mid-20th century.

The answer is a new compact that gives Americans enough security to accept economic change. Suppose, for example, lower and moderate-income workers got a larger share of today's productivity gains through a much bigger Earned Income Tax Credit starting at, say, $6,000 for those who earned the least and gradually tapering off well into the middle class. This would go a long way toward easing the pocketbook concerns of Americans who are working harder but getting nowhere.

To cushion the pain of job loss, unemployment insurance should be turned into re-employment insurance, helping people to get new jobs instead of keeping them waiting for old ones to return. Community colleges would do the retraining, in league with area businesses that identified skill shortages. Wage insurance would cover part of the difference between their old salary and their new starting wage.

Of course these ideas are not the brain child of Robert Reich. The Earned Income Tax Credit (EITC) is a negative income tax, a term and concept devised by Milton Friedman in 1962 (here is an overview of the concept and its implementation). Calling for a rise in the EITC is nothing new either. In fact, since 1986 it has been raised three times and to continued success.

The concept of re-employment insurance is a new one, recently popularized by Thomas Friedman in his bestseller The World Is Flat. But Reich does no justice to the beautiful intracies and possibilities of re-employment or livelihood insurance. Back in beginning of 2004 the Atlantic did:

...Robert Litan, an economist at the Brookings Institution, and Lori Kletzer, an economist at the University of California at Santa Cruz, have proposed a fairly inexpensive extension of unemployment insurance to cover workers who find new jobs that pay much less than their old ones. "Wage insurance" would make up a portion of the difference between old and new incomes for up to two years, so that the transition to a lower-income lifestyle would be more gradual. (A pilot program already exists for workers displaced by the movement of jobs overseas.) But wage insurance has potential as more than just a safety net; if unemployed workers knew they could more easily afford to take lower-paying jobs, they might feel freer to jump into whole new industries or career tracks; this would help the economy grow faster (by increasing the speed at which new industries grow) and might also ultimately increase the long-term income prospects of individual workers.

A more radical variation on this concept comes from Robert Shiller, an economist at Yale, who believes that continuing financial-market innovations may soon enable private insurers to offer "livelihood insurance" that could protect workers from potential declines in their occupations (though not against an individual worker's underperformance within a flourishing field). Similar products might insure against the eventual devaluation of specific academic degrees in the United States (such as those in software engineering or Russian language), or even against declines in the performance of the U.S. economy as a whole, relative to the rest of the world. (As Shiller notes, the fact that the past century was a good one for America does not necessarily mean that the next one will be.) Collectively, these products might lessen the large and arguably increasing risks inherent in the U.S. capitalist system.

These are bold ideas; it may be hard at first to wrap one's mind around them. And it is perhaps ironic that financial markets—which are regarded by many people as amoral if not immoral—might ultimately solve some of the problems that socialist and utopian thinkers have been trying for centuries to address. But as improbable as livelihood insurance may sound, advances in data collection, data analysis, and financial-risk theory are lowering the technical barriers to such a system. Government action could help the creation of livelihood insurance on a large scale. Part of the government's role would be technical—for instance setting the standards for the collection and sharing of personal income data that are necessary if livelihood insurance is to work. But two equally important tasks would be the articulation of a new vision of society—one where people are protected against the unexpected shocks that accompany rapid economic change—and the promotion of financial-services products that can sustain that vision. Without large markets covering a wide range of occupations, carriers offering livelihood insurance might have difficulty hedging their risk sufficiently.

Economists argue that the benefits of technological advance, freer trade, and greater competition are great enough that when—as inevitably happens—some people suffer as a result of these forces, those people can in theory be fully compensated for their losses. But in practice such workers are rarely, if ever, compensated—and the consequences of the setbacks they suffer are more severe in the New Economy than they were in the past. Our economic (and political) system can tolerate a certain level of inequality resulting from differences in ability and work ethic (though just how much is an open question). But too often inequality is gratuitous; many people's economic fortunes are buffeted by factors they cannot reasonably predict and over which they have no personal control. As a society we should seek to minimize the randomness of fortune that is inherent in democratic capitalism.

So now the discussion moves from how effective are these two suggestions to why the hell aren't we implementing them now. Sadly the answer is that the EITC and spending a couple million to compile data for livelihood insurance are not sexy concepts. They do not win any votes. This week more than any should highlight that. Voters look for decisive leadership in their politicians, especially in times of crisis. Also, voters often become rooted to a party purely out of belief in certain moral issues. Both of these sectors of politics would be woefully under addressed by your average economist/ champion of increased EITC and livelihood insurance. Just imagine Alan Greenspan attempting to console victims of Hurricane Katrina or appointing a Supreme Court justice because of certain stances on property rights.

But it is here that we reconnect with Robert Reich, who provides a masterful diagnosis:

But the new insecurity is undermining our national interest in other, less predictable ways by setting off political resistance to economic change, with negative repercussions that ripple beyond the economy.

Forty years ago, free-trade agreements passed Congress with broad backing because legislators recognized that they helped American consumers and promoted global stability. But as job and wage insecurity have grown, public support for free trade has declined. The North American Free Trade Agreement, which passed by 34 votes in 1993, was a hard sale for the Clinton administration. But the recent Central American Free Trade Agreement, embracing a far smaller and less populous area, was an even harder sale for President Bush. Despite Republican control of Congress, the trade deal cleared the House in July by just two votes, and then only after heavy White House pressure.

The increasing insecurity of ordinary workers also imperils our national defense by handcuffing the Pentagon. It can't shift the defense budget to fighting terrorism because of local fears that well-paying jobs will be lost. Contrast this with the comparative ease by which the Pentagon downshifted from fighting World War II to the cold war, more than 50 years ago. Its recent base-closing recommendations ignited a political firestorm, causing even the apolitical Base Closure and Realignment Commission to retreat. The commission's chairman justified its decision to save the Niagara Falls Air Reserve Station, for example, by noting that the base "is the second-largest employer in western New York."

Consider, finally, the pork that's been larded into the federal budget. Republicans may collectively oppose wasteful spending, but as individual legislators they've created more pork than any Congress in history. The new $286 billion transportation act is bloated with 6,371 "special projects" with a price tag some $30 billion more than the White House wanted. The president reassured the nation that it would, at the least, "give hundreds of thousands of Americans good-paying jobs." The new $12.3 billion energy bill cost twice what the White House sought because it's laden with what Senator Pete Domenici, the New Mexico Republican who ushered it through Congress, defends as measures to create "hundreds of thousands of jobs." According to the conservative watchdog group Citizens Against Government Waste, pork programs have risen from fewer than 2,000 a year in the mid-1990's to almost 14,000 this year.

Don't blame the politicians, though. Whatever the policy at stake - trade, defense, transportation, energy - it's likely to morph into a jobs issue because that's what's most on people's minds. So politicians concerned about re-election will do what they can to protect jobs against free trade, base closings, or whatever else might threaten them; and to create jobs by getting as much pork as possible.

Unfortunately no economist has a cure for this diagnosis. This is a problem purely of politics. Right now George Bush is in perfect position to address many of these issues, he is a lame-duck president and can for the first time in his presidency begin to look towards the distant future (instead of the next election). He began to do that with his proposal on Social Security reform. When many political analysts described Bush's motivations for Social Security reform they often cited his urge to leave a lasting legacy; to reform one of the most popular government programs for America's future generations. Bush ought to realize he has the opportunity to leave just as significant a legacy with the creation and further entrenchment of livelihood insurance and the negative income tax. These programs could very well become the rigid backbone of the hypersensitive twenty-first century economy.

-Mr. Alec