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USA SWEEP: Jobs, GOP, Fiscal Cliff

Prof. Peter Morici - 1/20/2013

I. Self-Inflicted Wounds Threaten Jobs Market Meltdown

Friday, the Commerce Department reported the annual deficit on international trade in goods and services remained about $500 billion a year. Along with higher taxes and other antigrowth policies, this deficit slows recovery and threatens to thrust the economy into a second recession and push unemployment to truly painful levels.

Consumer spending continues to expand, though haltingly, and the annual federal deficit has increased from $161 billion before the financial crisis to more than $1 trillion, injecting enormous additional demand into the system. However, too many of those dollars go abroad for Middle East oil and Chinese goods that do not return to buy U.S. exports, and higher oil prices will up the trade gap in 2013

Businesses, consequently, are pessimistic about future demand for U.S.-made goods and services, and bearing higher corporate and other business taxes than foreign competitors, rising employee benefit costs mandated by Obama Care and more cumbersome business regulations are reluctant to hire in the United States.

Although rising wages in China are making U.S. locations somewhat more attractive than in recent years, cumbersome business regulations add costs and slow, and even stifle, Greenfield investments and expansion of existing facilities. According to the U.S. Chief Executive of Flextronics International, a world-wide product design, logistics and manufacturing services company, a manufacturing plant for 5000 employees can be set up in Asia in 90 days but it takes much longer in the United States.

Those barriers have slowed the manufacturing renaissance and frustrated the virtuous cycle of temporary tax cuts and additional government spending, new hiring, and additional household spending the first-term Obama stimulus sought to beget.

Now the Fiscal Cliff deal will raise combined federal and state tax rates for many small businesses on expansion and reinvestment to maintain existing facilities to more than fifty percent. Look for multinational corporations to shift sourcing and jobs from many U.S. small enterprises to Asia.

Prior to the Fiscal Cliff tax increases, economists predicted growth of about 2 percent for 2013. However, these new taxes on small business investment and innovation strike at the heart of this once vibrant American jobs creating machine—look for growth in the range of 1.5 percent and a tougher jobs market.

Growth below 2 percent is difficult to sustain—any disruption could set off a cycle of layoffs, falling consumer spending and ultimately a recession that pushes unemployment into double digits.

Imported oil and subsidized imports from China account for the entire trade gap. President Obama has talked repeatedly about developing the full range of energy resources, but has toughened counterproductive limits on oil production in the Gulf, off the Pacific and Atlantic Coasts, and Alaska.

Development of new onshore reserves in the Lower 48 has not delivered enough new oil, and full push on U.S. reserves would cut U.S. imports in half. Shifting federal subsidies from cost ineffective electric cars, wind and solar to more fuel efficient internal combustion engines and plug-in hybrids could further cut U.S. petroleum imports.

To keep Chinese products artificially inexpensive on U.S. store shelves, Beijing undervalues the yuan through intervention in currency markets. It pirates U.S. technology, subsidizes exports and imposes high tariffs on imports. Other Asia governments, most recently Japan, have adopted similar policies to stay competitive with the Middle Kingdom.

Economists across the ideological and political spectrum have offered strategies to offset the deleterious consequences of currency strategies on the U.S. economy and force China and others to abandon mercantilist policies. However, Beijing offers token gestures, knowing President Obama will not take the strong actions.

Cutting the trade deficit by $300 billion, through domestic energy development and conservation, and forcing China’s hand on protectionism would increase GDP by about $500 billion a year and create at least 5 million jobs.

Longer term, large trade deficits shift resources from manufacturing and service activities that compete in global markets to domestically focused industries. The former undertake much more R&D and investments in human capital.

Cutting the trade deficit in half would raise long-term U.S. economic growth by one to two percentage points a year. But for the trade deficits of the Bush and Obama years, U.S. GDP would be 10 to 20 percent greater than it is today, and unemployment and budget deficits not much of a problem.

II. Remaking the GOP

For the GOP to win elections, it must offer voters what they want, and pathways to a more prosperous and livable America.

The country is more than just more multiracial, it has shifted fundamentally in its practice of tolerance.

While white Americans may lament the challenges of coping in a much more diverse society, they recognize the entire economy is dependent on Hispanic and Asian immigrants. And by winning 70 percent of their votes, President Obama demonstrated the GOP’s anti-immigration makes it unelectable, even among socially conservative and more prosperous Hispanics and Asians.

Gay bashing and ending funding for Planned Parenthood are for GOP politicians aspiring to perpetual minority status.

While downplaying GOP positions on “core pro-family issues” would soften GOP support among southern protestant conservatives, those folks are a dwindling share of the electorate. In the last election, social issues got trumped by immigration reform among generally Catholic Hispanics and economic issues among blue-collar northern whites. And most white professionals, who may live according to those values, increasingly are disinclined to support the regulation of private lives or deny others’ legal protections and full access to reproductive choices.

On the economy, the GOP should offer attractive alternatives to the liberal agenda, not where it has succeeded, but where it has failed—on growth and jobs.

Favoring tax cuts for the wealthy is a proven loser and personal income tax reform is a political dead end.

The Bush cuts were proportionately more generous to low and middle income folks--it was those that created an America where 50 percent pay little or no taxes. Mr. Obama’s recent victories merely enshrined that, and jacked up taxes for the well off.

The new tax law makes deductions benefiting most ordinary folks—like mortgage interest, state taxes and charitable contributions—only marginally valuable to families earning over $400,000. Tightening up the personal income tax code would overwhelmingly raise low- and middle-class taxes, and that’s a nonstarter.

The corporate tax code needs fixing. Many businesses—especially, domestic manufacturers and small businesses—are often more heavily taxed than competitors abroad, while large multinationals and some other players get off easily. That bias exports middle class jobs, and linking tax equity to growth should be the GOP stalking cry.

More fundamentally, though, Mr. Obama has fallen victim to fallacies in conventional wisdom on free trade, energy independence, and the environment, and those slow the recovery. Early in the tenures of Presidents Reagan and Obama, unemployment reached double digits, but at this point in his presidency the Gipper had the economy growing at a 6.3 percent annual pace.

The $500 billion dollar trade deficit is a huge drain on growth. China accounts for the lion share of that gap and oil imports the rest, despite recent surges in oil and gas production from on-shore fracking.

Free trading economists across the spectrum advocate denying China and others the benefits of subsidizing its exports with undervalued currencies, so that trade can be based on genuine competitive advantages.

Early on, the Obama Administration became fixated with the BP Horizon disaster and put in place unworkable regulations on drilling where the big U.S. oil reserves remain. Freeing up the Gulf, Atlantic and Pacific Coasts, and parts of Alaska, could cut petroleum imports in half—and lower environmental risks, because those could be better managed here than in similarly difficult environs in developing countries.

Spread out populations makes mass transit and electric cars too expensive, and solar, wind and nuclear cannot compete in the wake of cheap, clean natural gas.

America does need to use less gasoline—populations must become more compact and rely more on smaller, fuel-efficient conventional and hybrid vehicles better attuned to city living.

Young people see all this and where they can are moving back into and closer to urban cores. They like the cultural amenities and automakers are shifting offerings toward their needs.

Republicans need to abandon their bias toward suburbs and become champions of livable cities and a revolution in personal transportation—that would foster a lot of private sector growth and offer younger Americans reason to give the GOP a second look.

By offering sensible strategies on trade, energy, and the environment, in the context of the urban renaissance, the GOP can appeal across the electoral spectrum.

III. Unemployment Rate Steady as Millions Remained Discouraged

The economy added 155,000 jobs in December, down a bit from 161, 000 in November.

Unemployment was steady at 7.8 percent, largely because few of the millions of discouraged workers did not begin seeking work.

Fears regarding the fiscal cliff contributed to the continued slow pace of jobs creation; however, the overall picture is worse than these headline figures reveal and will remain difficult until the policy fundamentals change.

In the weakest recovery since the Great Depression, most of the reduction in unemployment from its 10.0 percent peak in October 2009 has been accomplished through a significant drop in the percentage of adults working or looking for work. Were adult labor-force participation the same today, the unemployment rate would be 9.7 percent.

Adding in part time workers who would prefer full employment but can’t find it, the unemployment rate becomes 14.4 percent. It rose above 14 percent in the wake of the financial crisis and remains stuck there.

Convincing millions of Americans they don’t want a job or compelling desperate workers to settle for part time work has been the Obama Administration’s most effective jobs program.

Growth remains weak, as most of the pickup to 3.1 percent in the third quarter was attributable to increased federal spending inventory build and a temporary surge in exports. Consumer spending and business investment weakened, substantially, and goods piled up warehouses—either in the fourth quarter or early next year, inventories will be adjusted and growth will slow. Exports will slow as Europe’s recession continues, and government spending will likely be curtailed in the upcoming debt ceiling negotiations.

Higher payroll taxes for all Americans, and higher income taxes for families earning more than $450,000 a year will hit small businesses very hard, as most are organized as limited liability corporations, the income of those entities pass through to personal income tax returns and will be taxed at the new higher rates.

Going forward U.S. GDP growth could easily dip below 2 percent. A deal to raise the federal debt ceiling taxes and slices spending by $200 to 250 billion, immediately, could send the economy into a recession and unemployment to above 10 percent.

The puzzle of reducing federal deficits to sustainable levels and accomplishing stronger growth and jobs creation, consistent with the underlying potential of the economy, remains difficult, because the $500 billion trade deficit on oil and with China continues to drag on demand and a tighter regulatory climate makes businesses cautious about investing in the United States.

The economy would have to add about 12.9 million jobs over the next three years—about 358,000 each month—to bring unemployment down to 6 percent. That would require GDP growth in the range of 4 to 5 percent.

Without better regulatory and trade policies, it is simply not possible to accelerate growth, create enough jobs and bring down federal deficits—all at the same time.

IV. Budget Deal Will Push Up Unemployment

The economy added 155,000 jobs in December—substantially less than is needed to pull unemployment down to acceptable levels.

The tax and spending package passed by the Senate and House provides little prospects of improvement, as the U.S. economy continues to suffer from insufficient demand and will continue growing at a subpar 2 percent a year.

Factors contributing to weak demand and slow jobs creation are the huge trade deficits with China and other Asian exporters and on oil. However, on the supply side, increased business regulations, rising health care costs and mandates imposed by Obama Care, and now higher taxes on small businesses discourage investments that raise productivity and competitiveness and create jobs.

Higher social security payroll taxes were already rolled into growth projections for the New Year. The budget deal raises about $40 to 50 billion annually from higher rates on family incomes above $450,000 but also extends other spending programs that were set to expire—for example, long-term unemployment benefits; therefore, the new net impact on aggregate demand is not large.

On the supply side, higher taxes on small businesses will reduce returns on investment—this will slow capital spending and new hiring in 2013 and even more next year.

Small businesses now have more certainty—the assurance of more burdensome regulations, health care costs and taxes and this will burden growth.

The economy must add more than 356 thousand jobs each month for three years to lower unemployment to 6 percent and that is not likely with current policies. That would require growth in the range of 4 to 5 percent. Without better trade, energy and regulatory policies and lower health care costs and taxes on small businesses, that is simply not going to happen.

Most analysts see the unemployment rate inching up to 7.8 percent, while a few see it remaining steady. The wildcard is the number of adults actually working or seeking jobs—the measure of the labor force used to calculate the unemployment rate.

Labor force participation is lower today than when President Obama took office and the recovery began, and factoring in discouraged adults and others working part-time that would prefer full time work, the unemployment rate is 14.4 percent.

Though Congress has postponed Sequestration, the posture taken by the President in negotiations with Speaker Boehner and by Vice President Biden in negotiations with discussions with Senate Minority Leader McConnell indicates the Administration and Democratic lawmakers have little interest in substantially curbing health care spending and retirement benefits.

The likelihood of a downgrade in the U.S. credit rating by Moody’s is increasing, and this will weigh on the investment plans of many U.S. multinational corporations—they invest and create jobs in Asia, where national policies better favor growth, instead of the United States where higher taxes, spending and deficits are out of control.

Peter Morici is a professor at the Smith School of Business, University of
Maryland School, and former Chief Economist at the U.S. International Trade

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