US economy – thinking liberal

Is America having a Brexit moment?

In my last post on the US election, I forecast victory for Donald Trump. That was just before Joe Biden stood down – which happened within hours. In a postscript I suggested that the economy and immigration would still swing the election for Mr Trump. So it proved, though as I watched Mr Trump melt down in the first months of Kamala Harris’s candidacy, I thought she might do it – even comfortably. But then Mr Trump’s campaign stabilised, and returned to consistently hammering the points that would swing voters, and he won comfortably. I thought Ms Harris fought a good campaign in the circumstances, but she had no answer on those two critical themes.

And so an earthquake has hit US politics. Mr Trump is much better organised than he was in 2016, and his personnel changes in the American state will be more sweeping. Meanwhile the complacency of the Democrats after beating him in 2020 has been badly exposed: there will surely be something of a clearout on their side. I don’t go along with the idea that this is the most consequential election of our times (which could be applied to 2016, 2020 or 2028 with equal merit) – but the changes will be drastic. To me it evokes nothing more than that what we experienced in Britain after the Brexit referendum in 2016.

Of course 2016 was when Mr Trump was first elected, and we thought that was a Brexit moment too. But his first administration descended into muddle and was reversed in 2020. The equivalent of the first phase of Brexit happened – the chaos after the referendum result as the country turned rudderless, but not the second – which started with Boris Johnson’s landslide election victory in December 2019. It is the equivalent of that second phase that is starting now in America. At first Mr Johnson’s election victory overawed everybody. His supporters projected their favoured outcomes onto the result, and there was much hubris, as his opponents retreated to lick their wounds.

The similarities between Mr Johnson and Mr Trump are striking. Both won by making a series of impossible promises and relying on humour and bluster to persuade voters to give them the benefit of the doubt. Both are personally quite transparent – what you see is what you get – giving a feeling of authenticity compared to other politicians. Both favour loyalty among their choices for political office over competence. They even both have brought in highly intelligent mavericks to spice up their administrations (Dominic Cummings in Britain, Elon Musk in America). It did not go well for Mr Johnson: his chaotic regime collapsed in not much over two years, getting himself replaced by an ideologue who destroyed what was left of his party’s reputation (Liz Truss) – a mess that his eventual successor, the lightweight Rishi Sunak could do nothing to reverse. It was the most spectacular reversal of political fortunes in British history. Will this history repeat? A chaotic regime which results in Mr Trump bowing out prematurely, followed by an even more disastrous lightweight ideologue (JD Vance)?

Maybe. But we need to think about the differences between the two situations. Firstly the two men. Mr Johnson is by far Mr Trump’s intellectual superior, but he had little organisational experience. He couldn’t run a whelk stall, in the British expression. Mr Trump is an experienced businessman, who certainly could run a whelk stall (“the best whelk stall in all the world”), even if his track record is nothing like as good as he says it is. He may not be particularly intelligent in the normally accepted (left-brained) sense, but he has drive, stamina, confidence and intuition that make him very effective in his own way. His management style is chaotic, but there is more method to his chaos than with Mr Johnson, and he is more adept at blaming others if anything goes wrong (Mr Johnson did this too, but without the same chutzpah). And America’s president is far more entrenched constitutionally than Britain’s prime minister, who is at the mercy of parliament. Mr Trump thrives on attention and status, which the job of US president delivers more than any other – it is hard to see him voluntarily letting go. This would take some sort of physical health issue – though this is a clear risk at his age.

But there are going to be problems. His administration will be peopled by chancers and mavericks, who will under-deliver. That happened last time, though in a different way to what is likely to happen this. In the short term I see this as doing little political damage to him though. There will be ethical issues galore – but (unlike for Mr Johnson) these have little capacity to damage him. Failure to deliver on practically anything doomed Mr Johnson and his successors (even Brexit had a big flaw in Northern Ireland); Mr Trump’s downfall is likely to be over-delivery. Mr Trump has made three major policy promises: the mass deportation of irregular immigrants; the raising of tariffs; and reducing taxes. Even partial delivery on these promises will make America worse off. They might have longer term economic benefits (though I’m a sceptic) but these will not come through in time.

It is very hard to see how Mr Trump’s deportation strategy will unfold – it is so unprecedented. But he has laid huge store on it. At a minimum it will create huge uncertainty in the country’s labour markets, and surely many labour shortages. He may try to releive the shortages by relaxing legal immigration, though this looks politically suicidal, but that won’t happen without massive disruption. This disruption will lead to inflation – with the highly sensitive area of food prices looking especially vulnerable. Inflation was the economic event that did most damage to Mr Biden’s reputation, and it will upset many of those that voted for him on the basis of his supposed economic competence.

Something similar will happen on tariffs. These are so obviously harmful that many of Mr Trump’s business backers assume that his policy is simply a negotiating tactic. Nothing, it seems, will dampen their wild optimism, reflected in a stock market rally. But tariffs are central to Mr Trump’s economic outlook. He appears to think that they will be costless to consumers, and raise revenue with which he can cut income taxes. Besides, it is surely hard to negotiate the kind of change to the terms in trade that he so wants. High tariffs will raise the prices of imported products and so inflation. This may not be as disastrous for America as it would be for some others, like Britain, who depend more on trade. But if prices are already going up because his migrant policy has disrupted labour markets, it doesn’t look good.

And then there are tax cuts. Many of Mr Trump’s business supporters set huge store on these, but there is a real problem with the country’s already-huge budget deficit. Adding to this deficit will be inflationary – one of the things that undid Mr Biden. His regime may want to balance this through drastic cuts to public spending (though not to defence), but there is not enough beureaucratics waste, wokery and foreign aid to deliver anything like enough – which would find him cutting into entitlements such as pensions (social security) and medical schemes. That won’t be an easy sell.

All three of Mr Trump’s main economic policy ideas point to inflation and administrative chaos. This will create stormy seas quite unlike his first administration. This is another difference from Brexit, which has proved to be a slow bleed rather than the big dislocation that some predicted. With his regime’s reputation for economic competence shattered there is liable to be a big backlash.

That should be an opportunity for the Democrats – just as Mr Johnson’s collapse was an opportunity for Labour in Britain. It is also possible that a different strand of populist radicalism emerges from the Republican side to take over. Meanwhile in the wider world, the retreat of America from its leadership position will force others to step up. There will be too much collateral damage for this to be a nice thing to watch – but it will be fascinating if you can see beyond that.

The American economy’s success is driving the toxicity of its politics

“Don’t bet against the American economy,” says The Economist in a recent special report. I understand where that sentiment is coming from. Over the years I have read many prophesies of doom, or at least of decline, for that economy, and often found them persuasive. On each occasion they have proved false. Two thoughts have struck me from this report: first that America’s success can’t be replicated by Europe, and that Europeans shouldn’t try; and second that America’s economic success, paradoxically, lies at the heart of its toxic politics. It is that last paradox which might cause the American success to unravel, as, to be fair, the report acknowledges.

My first insight flows from the principle of comparative advantage – a core economic insight originally articulated by David Riccardo in the 18th/19th Century. It is part of Economics 101, and is the critical idea about what drives international trade, and why such trade is mutually beneficial even if one economy imports stuff that it could make more efficiently for itself. It’s all about opportunity costs, as more modern language than Riccardo’s would have it. At a strategic level the theory of comparative advantage has massive predictive power – explaining so much of the world economy as we see it, including, for example, why exchange rates don’t match purchasing power parity. But as you try to get into more detailed, and tactically useful, predictions, economists have been unable to turn it into anything more precise, in spite of one or two attempts. Therefore it is left out the economic models that drive so much of the work of economists, and it does not progress beyond Economics 101. That is why so many economists, not least writers at The Economist, often forget that it is there and seem ignorant of how it actually plays out. So far as I can see, the great (and late) economist Paul Samuelson is one of the very few economists of modern times to properly have internalised its implications. He it was who pointed out that as undeveloped economies converged with advanced ones, the gains from trade between them would diminish, at the expense of the advanced economies. This does much to explain the relative economic stagnation of advanced economies since the financial crash of 2007-09, compared with the era of rampant globalisation before it (which happened after Samuelson died, having forecast it) – though there are other factors, not least demographics. And yet this is never mentioned amid the wringing of hands about the backlash against global trade, which is generally blamed on politics alone. And yet the invisible hand is so often behind the politics.

I have a another insight arising from Riccardo’s thesis. America’s recent success compared to Europe, as The Economist‘s report points out, is based on high-tech industries, where productivity has soared, while it has plodded elsewhere. This success is surely based on the scale of America’s market, and the relatively lack of legal and cultural barriers to trade and the movement of labour. This is clearly a source of comparative advantage over Europe – though not to China, which has a very similar advantage. This means that the relative productivity of the tech sector compared to others (making aircraft, for example) is always going to be greater in America than in Europe, apart from a few specialist niches. That will drive America to specialise in hi-tech industry, while Europe’s direct competitors will diminish – to the benefit of both, as an Economics 101 student can readily explain. If this the way of the invisible hand, then why does The Economist (and such luminaries as Mario Draghi the EU éminence grise with an economics training) spend so much time bemoaning Europe’s lagging hi-tech industry and urging it to to try harder? Economically literate politicians, like Mr Draghi, often do this sort of thing because it is a convenient argument for policies that are actually about economic efficiency in general . Journalists in more sophisticated publications have no such excuse. Europe is never going to match America, or China for that matter, in some areas and it will be a waste of effort trying. Meanwhile they are doing well enough exporting the many products where they do have comparative advantage – Europe does not operate with a large trade deficit, after all. Of course European leaders must keep trying to improve economic efficiency, and perhaps watching America will act as a spur, but a clearer understanding of the workings of comparative advantage would mean better-directed public investment.

Back to America. The Economist does not fail to attribute some of America’s success to an entrepreneurial zeitgeist – but it points to more solid factors too. First is that it has comparative advantage in industries that happen to be highly productive – not just in hi-tech, but also oil and gas. The former advantage stems from the size and flexibility of America’s product and labour markets – something that only China matches (India seems to be closer to Europe in this respect); the latter from a geological endowment. That’s all very well, but it creates tensions. The successful industries take off, but the corollary is that many others are left behind – and through the laws of comparative advantage – become less internationally competitive (as the dollar strengthens, and as they have to pay workers more to compete with the more productive sectors). This creates what Donald Trump calls “American carnage” – the flip side to economic flexibility, as factories close and more productive workers flee to the booming parts of the country. How much the imbalance between globally successful industries and the mainstream is driving high inequality is an interesting question. The Economist suggests that the poorest quintile has seen significant income growth in recent years with tighter labour markets – but in the middle of the income distribution there may be more stagnation – as the higher income groups continue to do fabulously. But if things happen quickly in America, the human cost is going to be high. Rapid growth breeds “carnage”.

A further source of advantage, according to The Economist, is access to large numbers of immigrants, and not least those flooding across the southern border. This seems to act as a lubricant: jobs get filled more quickly in the growing parts of the economy. Europe has immigrants too (though not China) but finds these harder to integrate. And yet this is a central driver to the country’s toxic politics.

And so the rapid change to the structure of the US economy, and the flood of immigrants that its success attracts, are driving a sense of dislocation among Americans, which in turn is driving the highly destructive direction of US politics. This is placing all its critical institutions under threat. Four dangers lurk in particular: the capture of US institutions by a big business elite (“rent-seeking” in economic jargon); rolling back international trade through tariffs and other measures; clamping down on immigration; and finally macroeconomic instability arising from public finances going out of control.

The concentration of big business, leading to capture of the political system and the corruption of institutions to protect established business from competition (often in the name of social stability), is a familiar process. We see variations of it in many places (although sometimes, as in Russia and Hungary, the relationship between political leader and business elite is more complex) – and , indeed, it is alleged to have happened in America in the late 19th Century. The concentration is happening in America now, as is the business elite’s dabbling in politics (most egregiously by Elon Musk) – but The Economist does not think it is leading to significant anti-competitive practices. Competition between the major hi-tech companies remains intense and the pace of innovative product development is hardly slowing. We might raise eyebrows about the way money buys influence in the US, but it does not appear to be a big threat to the US economy.

The backlash against foreign trade is a more substantive concern and especially the advocacy of tariffs. This seems to be mainly driven by Donald Trump – and as such it is one of his most distinctive contributions to economic policy – but the Democrats are copying him. It is hard to see how such policies will do much to help the American public – their main effect will be to raise costs. However it may not do much damage to the main drivers of US economic health: the technology giants and the oil and gas industries. It is not good news for the rest of the world, however, especially Europe.

Anti-immigration will also probably not hurt as much as it could – unless Mr Trump is actually tries to fulfil his campaign rhetoric about mass deportation. The Economist is also quite sanguine about the impact of public budget deficits, which few politicians seem to be taking seriously. There remains little threat to the US Dollar as the world’s preeminent currency, and hence the ease with which dollar finance can be obtained.

Still, there does seem to be an unhealthy cycle here. Growth in the American economy remains robust, but it is driving US society apart. Politicians and commentators alike focus on the choices at the next election, always described as the most important in modern times. But neither side is able to deliver a killer blow to the other. If Mr Trump wins next week’s election, his movement will have to find ways to survive his departure, amid the inevitable chaos of his administration. If Kamala Harris wins it is hard to see that she can convince Trump supporters that she is taking America along the right course, continuing to fuel the destructive radicalism of the right. One way or another this political toxicity will surely affect the astonishing robustness and resilience of the US economy that is one of its main drivers.

The economics of the pandemic: don’t panic

One of my favourite subjects in ten years of blogging has been economics. But for the last year I have hesitated. There has been a lot to write about, but somehow I did not have the confidence to say anything. A couple of weeks ago I got as far as writing an article, but it just meandered. But this week I have been bombarded with different opinions on the impact of the pandemic and what to do next, so I feel I must try to make some sense of it.

Most recently there were a couple of articles in the FT. There was an interview with economist Dani Rodrick, in which he urged that the left should make up for its attachment to neoliberalism in the 1990s and 2000s and meet the challenge of right-wing populism with a sort of left-wing populism. The focus of this should be the creation of decent jobs (the populism bit being the blaming of everything on plutocrats and bankers). He has certainly hit on something important, but to me left-wing populism brings to mind the late Hugo Chavez, and the creation of useless jobs given to political cronies, the running down of productive industries and bankrupting the economy on welfare programmes used to shore up politically compliant communities. This is where the policies of Labour’s former leader Jeremy Corbyn would have led in my view (he is a fan of Chavez after all). On the same day the neoliberals fought back with a piece by Ruchir Sharma, a banker, who claims that emerging market economies have responded to the crisis by pressing forward with supply-side policies, rather than splurging on stimulus. These are IMF-style programmes without the IMF – he points to China and India, amongst others. With developed economies resisting such reforms, he says these emerging economies will be better placed to overcome the shock. This is an interesting take on what is happening, but the conclusion is facile. Developed economies are at the productivity frontier, and they are not in need of many neoliberal reforms (with some exceptions such as Italy) – I agree with Mr Rodrick here, even if his picture of left-wing populism sends shivers down my spine.

And then we have some writing about President Joe Biden’s proposed massive stimulus for the US economy (£1.9trn is the headline). Left-wing commentator Robert Reich launched into enthusiastic support on Facebook. The Economist thinks it goes too far, and should be better targeted, echoing criticism from former adviser to President Clinton, Larry Summers. They fear that it will trigger inflation, and then rising interest rates, and a financial crisis. Meanwhile, also in FT, Gillian Tett has written about the remarkable stance of Chairman of the Federal Reserve Jay Powell, whom she thinks is being far to aggressive on the length of time he suggests interest rates should stay low. Meanwhile there is a lot of fretting about signs of overheated financial markets, with the popularity of crypto “currencies” like Bitcoin eliciting much angst.

There is quite a lot of agreement that governments are right to spend to support the economy, but a big concern on how far this should go. Critics of stimulus worry about setting off inflation. But conservatives have cried wolf on inflation many times in the last few years, and yet it remains stubbornly low. Most commentary on inflation misses the mark.

What is inflation? It is a devaluation of the currency, so that the same nominal units income or savings buy less, but that a fixed nominal amount of debt becomes easier to pay off. The focus of commentary tends to be almost entirely on the first, measured by overall movement in consumer prices. But if wages do not rise to match prices, then debts are not depreciated. It isn’t really inflation, in my books, but a structural adjustment. The three main reasons for this can be worsening terms of trade (i.e. imports becoming more expensive, usually because the exchange rate is depreciating), a decline in productivity, or a shift of bargaining power from labour to capital. None of these require the same policy response as inflation proper (i.e. higher taxes or reduced public spending, or higher interest rates). And in the 21st Century consumer prices and wages have rarely moved in line with each other in developed economies. Before the financial crisis of 2007-2009, wages trended ahead, largely because of improving terms of trade from cheap imports, mainly from China. After the crisis wages have usually failed to keep pace with prices, as the terms of trade moved against developed countries (Chinese products stopped getting cheaper), unmasking a steady process of the balance of advantage moving from labour to capital. All this is very different from the later 20th century, when most of the current theories of economic management were developed. Then wages and consumer prices usually moved in lockstep. The breaking of the link between prices and wages is one of the critical things to understand about the modern economy.

So what happens when demand runs ahead of supply? Inflation remains stuck because rising prices choke off demand, because wages for most people do not keep up. The typical response is for imports to rise. At least that is what I suspect from the limited times where this has happened in the 21st Century (I believe Britain in the mid noughties was a case in point). But a feature of modern developed economies, especially since 2007, has been a chronic lack of demand, while conservative government fiscal policies were the accepted wisdom.

So what will happen if President Biden’s stimulus gets going, with the Fed minded to keep interest rates low? I don’t think it will lead to more than a slight increase in inflation, largely because of the disconnect between prices and pay, but also because of the nature of the recovery. The Economist refers to some supply bottlenecks, such as in microchips, but these relate to distortions in demand arising from lockdowns. Assuming that the US comes out of lockdown, then the main rise in demand will be for services, rather than such manufactured goods, where there seems to be quite a deep pool of unemployed or underemployed labour. And doubtless imports will rise too, and the US dollar will strengthen relative to other currencies. Also much of the excess demand will be funnelled into asset markets, so the current distinctly bubbly markets could well continue. If there is trouble it will come from some kind of breakdown in financial markets. But they do not seem to be as vulnerable as they were in 2007. All this rather supports Mr Reich’s optimistic outlook. As the stimulus plays out things become a lot less predicable, but that is a couple of years away and not necessarily unmanageable.

What should the British government do? It has run up an astonishing budget deficit in its largely successful attempt to keep the show on the road in the crisis – unemployment is remarkably low I the circumstances. According the Economist the deficit is nearly 20% of GDP, the largest of any of the economies it follows. But the same statistical table shows something rather interesting: that the current account deficit to has fallen to 1.3%, and is unremarkable by international standards. Not long ago it was one of the highest. This, together with very low interest rates, suggests that there is no financial crisis, and therefore no need to panic, as the country did in 2010, when the budget deficit was 11%, though the current account deficit was a bit higher at 2 to 2.5%. The government’s main problem is its own rhetoric about government finances.

How quickly could things turn nasty in the UK? We are much more vulnerable to a financial crisis than the US, because we lack financial clout. But again we look much less vulnerable than in 2007. A big question is what happens if the current account goes sharply negative again. That is not necessarily unsustainable (it can be financed by selling property to foreigners). But if world interest rates should start to rise then problems might spiral. But my guess is that the country is safe for a couple of years at least.

There are some much deeper economic questions emerging from the covid crisis, which point to a major change in direction for economic management. These should occupy us more than short term government finances.

Making America small again. Trump’s victory marks the decline of the USA

“Make America Great Again.” That was the slogan of Donald Trump’s insurgent campaign to take the US presidency. It resonated with many Americans. They felt that the US had been subject to serial humiliations in its international dealings, and that Mr Trump’s more robust and confrontational leadership would help to reverse it.

But politics is full of paradox. To exercise power is to diminish it. Power accumulates to those who understand restraint. In Britain English and Welsh voters took to heart the slogan of “Take Back Control” and voted for Brexit. The country is now basking in the thrill of exercising direct power in its relations with its fellow European neighbours. And yet the result will be a medium-sized power adrift in a friendless world, seeking to trade freely when everybody else is becoming more protectionist It will be more rather than less subject to the whims of foreign powers. Britons may prefer it that way, but they will come to understand that the keys to “taking back control” actually lie in Westminster and their local council chambers, rather than in Brussels.

So it is in America. Mr Trump’s supporters will revel in the assertion their country’s direct power. And yet he will exercise this assertiveness in order to carry out a retreat. The result can only be diminishment, relegating the US to the middle part of a medium-sized continent.

Let’s look at some specifics. Consider the Trans Pacific Partnership (TPP): the multinational trade deal put together by President Obama. This was a central element of his Asian diplomatic strategy, designed to collect a number of Asian countries into America’s orbit in trading terms, conspicuously excluding China. Mr Trump (along with many Democrats) denounces this as a bad deal and will scrap it. That leaves a vacuum into which China is ready to pounce. It plans its own version of a free trade area, involving most of the same countries. Mr Trump has also questioned the value of America’s military alliances in the region. The clear message to countries there is that they must acquiesce with China’s increasingly imperial ambitions. The Philippines’ President Duterte looks a little less eccentric in his pivot to China. The USA is suddenly a much less important country.

Mr Trump’s promised assertiveness in trade relations with China makes little sense either. It comes at an important moment in the evolution of China as a nation. It has built its economy on international integration, especially with the US, and developed a large trade surplus in the process. But there is nothing particularly beneficial in a trade surplus – it implies that a country’s citizens are consuming less than they could – an act of self-denial. A trade surplus has political advantages – it makes you less beholden to foreign creditors – but China is already powerful enough for this not to matter much. So it is in the process of carrying out an economic pivot to develop its consumer economy, and away from integration with developed economies – though the scope for integration with less developed economies remains. An economic model where it exports less to America and integrates more with other Asian countries, and even African ones, suits it just fine strategically. Mr Trump means to hurry it along, but it will disrupt the US economy more than the Chinese one.

In Europe the issue is not so much trade. The proposed trade deal between the US and the European Union, TTIP, looks dead in the water without any help from Mr Trump. The main issue for Europeans is military and diplomatic support for the European countries against Russia in particular. Mr Trump has said that the current balance involves America in a disproportionate level of commitment. He has a point. If America steps back from its military commitments, and caves in to pressure from Vladimir Putin to create and extend a Russian sphere of influence, then it will put European countries in a very tough position. It is not very clear where this will lead – but one thing is very clear: America will be less important to Europe. This is not necessarily a bad thing for Europe, but it will be very uncomfortable.

And then there is economics. We are still guessing what will emerge from Mr Trump’s presidency – but there could well be a short-term lift for America. Some form of fiscal stimulus is in the offing. Mr Trump and his advisers hope to lure in US corporate profits that are stacked offshore for tax reasons, and to use the proceeds to fund infrastructure investment. Unlike many of his Republican colleagues, Mr Trump will be reluctant to cut state handouts, like pensions or healthcare – though health insurance is under threat. This could give a short term lift to the US economy . And, as this week’s Economist points out, much of this gain will be at the cost of other world economies.

That should please Mr Trump’s supporters. But the problems will start quickly. The stimulus is badly timed. In many aspects the US economy is running at close to potential output. All the stimulus might do is suck in imports and push up prices. But there may well be a lot of hidden potential in the US economy – more workers could be drawn into the workforce, and other workers could be made to work more productively. But if Mr Trump is serious about rolling back free trade and driving out foreign workers, then he will cut the capacity of the US economy when it needs to be increased. A financial crisis is in the offing.

The truth about the American economy is that, far from being taken for a ride and funding lavish lifestyles of foreigners, American consumption is being supported from abroad. This is what a trade deficit means. A transition to a more self-sufficient economy, as wished for by Mr Trump’s supporters, will entail economic shrinkage. Americans may rail at the loss of jobs in many industries, but they exchanged these for cheaper products, made abroad or with automated technologies, or both. Reversing that means reducing living standards.

Except that most Americans could still end up better off. If the country can share out income more evenly, with lower profits and higher wages, and more of those wages paid to middle and lower level employees and less to the top layer, then this shrinkage need not be painful to the majority. But what chance is there of a Republican administration, run by senior businessmen, achieving that? To Mr Trump exploitation is simply good business practice, and profits are reward for enterprise. There is no sign of a mindset that wants a different distribution of the fruits of economic success.

America and the world is in for a rough ride. But strategically it has been clear for a long time that American power, relative to the rest of the world, is in decline. That is not such a bad thing – it results from a fairer distribution of the world’s wealth. After the diminishment of Europe, it is now America’s turn. Mr Trump’s victory marks a big step along that journey. But it should surprise no follower of politics that he is claiming to do the opposite.

Is the US economy heading for a fall?

Most of the worry about the world economy is being directed towards Europe, and the Eurozone in particular. I am amongst a very small group of optimists on that front – but it is easy to see why people are worried. In fact it is only through a prolonged period of crisis that Europe will find an enduring solution. But meanwhile, should we be worried about the US too?

What prompted this thought was this article in Vanity Fair by the eminent economist Joseph Stiglitz (thanks to Marisha Ray for drawing my attention to this on Facebook). It’s subject is inequality, and why it is corroding the US economy, and why the elite (the top 1%) should worry. Judging by the FB comments, some readers saw this critique as applying to government thinking right across western world – the view that austerity economics is driven by an idealogical view of the role of government. But I took it as a very specific critique to the US.

Professor Stiglitz does not spend much time justifying the statement that inequality in the US is high and increasing. The problem is that almost all the benefits of growth are accruing to the top 1% of the population – and bypassing those on middle incomes. In other words the problem is not an underclass that is disappearing from sight – but a substantial majority of the population being left behind, with the creation of a fabulously rich elite. There are many ways of looking at the statistics on this, but for me one of the most important is the historically high level in national income that is taken up by business profits – the benefit of which goes overwhelmingly to the elite. This may or may not be outrageous in its own right, but Professor Stiglitz points out a number of practical problems that arise from this:

The very rich spend less of their income on consumption and save the rest. The more wealth that concentrates in their hands, the more consumption overall will fall as a proportion of the economy. Unless there are enough constructive channels for their savings then unemployment will result – unless alternative demand comes from somewhere. That alternative might be an investment boom (as with high tech in the late 1990s) or with big government deficits, propping up the economy now.
The rich elite use their power to protect vested interests and direct their energies to what economists call “rent-seeking”: activities that enrich the individuals themselves but not the economy as a whole. Under his analysis the finance industry is largely based on rent-seeking. As energies are diverted from genuine economic growth, the economy overall weakens. What is good for the profits of existing businesses is often not good for the whole economy – which needs new businesses to come forward.
The majority who are seeing their incomes stagnate, and find it more and more difficult to join the elite, get resentful, breaking down the trust that underlies all successful economies.

But there is a political puzzle at the centre of this. Why is the Republican Party both veering to the right and retaining substantial popularity? Surely the welling up of resentment against the elite should translate into overwhelming political pressure for a more egalitarian system? I think the American suspicion of government is to blame. I don’t think that the majority of American people are particularly happy with the way their living standards are being held back. But, incredible as it may sound to European ears, many of them think it is “socialist” government policies that are to blame. Shrink the government, cut taxes and the 99% will start to catch up with the 1%. Of course, huge funds from the elite are available to support this view in the media – through political campaigning and biased news coverage, such as Fox News. It hardly helps that a lot Americans seem to think they can have their cake and eat it: huge expenditure on entitlement programmes (especially Medicare) without the need for increased taxes.

If Professor Stiglitz is right then the US would be suffering from long term low economic growth, as the various toxic effects of its skewed income and wealth distribution gradually overwhelm the highly dynamic core economy. And indeed, measured per capita (i.e. taking into account population growth), the U.S managed annual growth of only about 1.4% in the first decade of this century (compared to the UK 1.7%, or Germany (1.9%) – though France only managed under 1% – figures from Wikipedia).

Still lacklustre growth won’t cause a crash. Italy has made an art of surviving such a challenge. But the proximate cause of a crisis is clear enough – the government’s budget deficit of 7.6%, and the lack of any political consensus in how to handle it. There are three ways in which this could cause a problem. The first is if the US government should hit the Spanish problem of being unable to borrow because of a loss of market confidence. This looks implausible. Investors have too few choices where to put their surplus funds. The second is expenditure cuts sucking demand out of the US economy, causing a prolonged recession. This could happen if the Republicans take control in this year’s elections. The third is political gridlock causing government funding to seize up, and causing technical default. This looks all too possible if the Republicans control either or both houses of Congress, as looks probable. Even if Mitt Romney should gain control of the presidency (and he’s doing well on fundraising), he may well run into trouble with Congress as he desperately tries to find practical answers to the deficit problem.

And what if the US survives the budget crunch in 2013? If growth continues to be lacklustre, and the top 1% continue to hog the benefits, surely US public anger will turn on the elite, as it did briefly in the last days of President Bush? I share the European view that a smaller government, reduced regulation and lower taxes will make the problem worse, not better. That will be a sight to watch from a safe distance.