Winning the Prosperity

Creating a New Economic Growth Path
March 15, 2011 |
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In the Fall of 2008 as financial markets were tumbling around the world, legendary investor Warren Buffet equated the bursting of the housing and credit bubble to an economic Pearl Harbor, one that could plunge the economy into a painful and prolonged downturn reminiscent of the 1930s.  Thanks in part to the lessons that were learned from the Great Depression, American and European policymakers won the immediate battle of preventing the economy from sinking into another Depression.  But they have not yet won the war to regain prosperity.  Not only do the U.S. and European economies remain vulnerable to a new economic downtown, but there are also major questions about what will drive economic growth in the post-bubble economy.  This is particularly true in the United States given the still heavily leveraged American consumer and given that the neo-mercantilist trade practices of large surplus economies, such as China, have so far blocked the normal path of trade adjustment.

In the aftermath of the World War II, American and European policymakers won the peace and subsequent prosperity by building new institutions, like the International Monetary Fund and the World Bank, and by undertaking reforms that ensured that workers from nearly all sectors of the economy shared in society’s wealth and prosperity.  These reforms made possible a form of Keynesian-oriented capitalism in which rising consumer demand from a growing middle class stimulated ever new rounds of private investment across a broad range of consumer and capital goods.  Government spending in turn smoothed out the business cycle and made substantial investments in infrastructure, public education, and research and development that contributed to future productivity growth.   The result of this effort was a generation of rising wages made possible by a strong Trans-Atlantic industrial economy and the creation of the social welfare state in Western Europe and the United States.

The foundations of this post-war Trans-Atlantic prosperity have long since been eroded by the combination of neo-liberal globalization, the information technology revolution, and the integration of more than two billion lower wage workers from China, India, and the former Soviet Union into the global economy.  Over the past decade or two, a new pattern of unbalanced economic growth has taken shape in the United States (and to a lesser degree in Europe) that proved to be too dependent on debt-financed consumption and inflated asset prices.

The root cause of this unbalanced growth was the rapid integration of the liberal American economy with the high-savings, lower wage economies of East Asia.  The fusion of these vastly different economies resulted in stagnant wages and rising corporate profits in the United States, on the one hand, and under-consumption and excess savings in the Asian export economies (as well as in the petrodollar states of the Persian Gulf, which benefited from rising energy demand).  The global savings surpluses from the Asian and petro-dollar economies were recycled into the U.S. financial system, fueling first the tech and then the credit and housing bubbles. The housing bubble in turn helped inflate consumption, as U.S. households took advantage of poorly regulated new financial instruments to purchase more expensive homes and tap rising home equity. U.S consumption in turn helped drive even stronger Asian investment and export growth, resulting in even higher trade surpluses.

The fatal weakness in this pattern of economic growth lay in the fact that U.S. consumption was made possible not by real wage and income gains but by unsustainable increases in home prices and household debt.  Not surprisingly when the housing and credit bubbles burst, economic growth came to a halt as households and financial institutions were forced to begin to rebalance their balance sheets. 

The U.S economy is now left with a large debt overhang, and political pressure is growing for government fiscal retrenchment even as private households continue to de-lever and even as unemployment and underemployment remain intolerably high.  Meanwhile, the world economy is experiencing contradictory economic conditions making standard macro-economic prescriptions less viable.  In many sectors, especially manufacturing, there are worrying levels of overcapacity and relative weak demand; and in other sectors, such as food and energy, there are equally worrying supply constraints and robust demand, as a result of strong industrial growth from China and other emerging economies.  Emerging economies must worry about growing inflation, while some developed economies are still struggling with deflationary pressures even midst rising food and energy prices. The question is how European and American policymakers navigate these conflicting winds to put the economy onto a new more balanced economic growth path. 

In the case of the United States, the Obama administration has at time spoken eloquently about establishing new foundations for the economy and has more recently outlined an agenda for “winning the future.”  This paper examines the extent to which the Obama program, along with the actions of the Federal Reserve, has succeeded in putting the economy onto a new economic growth path and what further options U.S. policy-makers have in the future for doing so. 

A New Growth Path or a Pale Version of the Old Pattern?

With the economy having grown at 2.8 percent rate in the fourth quarter of 2010, the Obama Administration and the Federal Reserve clearly deserve credit for preventing a prolonged economic downturn. But at the same time it is also clear that their efforts have fallen short of the goal of putting the economy onto a new growth path.  Indeed, the pattern of economic growth that has emerged from the economic recovery looks like a pale version of the debt-financed, consumption-led economic growth the United States experienced in the 2002-07 period, with public debt taking the place of private debt and with asset prices rising thanks in part to easy money and a new bubble in commodities and energy.

In part because of political constraints both at home and abroad, the administration’s program was not properly structured to create a bridge to a new healthy pattern of economic growth.    The economic recovery program itself relied too heavily on tax cuts that supported consumer demand and not enough on public investment (only 12 percent of the recovery package went to infrastructure spending, for example).  As a consequence, much of the stimulus leaked out of the economy or had little impact on job creation and investment, since companies could meet any additional demand from existing capacity and workforce levels.   The economic recovery program was also too small, especially considering the cuts that were occurring in state and local government spending, and thus the burden for stimulating the economy eventually fell disproportionately onto the Federal Reserve and its program of quantitative easing with the consequences that monetary reflation produced rising asset prices (except for housing) but little in the way of real job creation.

This mix of macroeconomic policy tended to reinforce the pre-crash pattern of economic growth rather than create a bridge to new sources of economic growth.  This is evident by looking at three key dimensions of the recovery—consumption and investment, wages and incomes, and net exports.  In order for a new pattern of more balanced economic growth to take hold, the following conditions would need to be met.

First, growth in GDP would need to rely less on consumption and more on investment, especially investment that leads to good jobs and rising wages.  Second, consumption will need to rest on rising incomes and wages not on debt-creation or the wealth effect from asset bubbles.  And third, growth would need to be driven more by rising demand from abroad rather than domestic demand as reflected in an improving trade balance and a strengthening of America’s tradable goods sector, including America’s energy sector.

Let’s look at each of these in turn.

i. Consumption and investment

Despite the highly leveraged American consumer, consumption has continued to drive U.S. economic growth during the recovery.   In 2010, the growth of consumer spending accounted for nearly 40 percent of overall GDP growth, contributing 1.27 percent of the 2.8 percent of GDP growth the U.S. economy enjoyed.  And rather than declining as an overall share of the economy, consumer spending as a percentage of GDP actually increased to an all-time high of 71 percent at one point in 2010.  The resiliency of consumer spending can be attributed in part to the economic recovery program, which tended to support general consumer demand with tax cuts, unemployment insurance, income support payments, and special tax breaks for consumption, like the cash-for-clunkers program.  On the positive side, the economy did see some improvement in capital expenditures, at least for awhile.  Capital spending on equipment and software expanded at a 15.1 percent annual rate in 2010, although it began to slow beginning in the third quarter of 2010 and actually declined in January 2011.   Overall investment levels in the economy remained relatively weak, rebounding less than consumption.

ii. Wages and incomes

Even more worrying than this continued over-reliance on consumption is the fact that consumer spending, much like in the 2002-07 period, has not been supported by real wage or income gains but by a combination of artificial supports: tax cuts, tax-related consumer rebates, and by government transfers.  Transfer payments now make up nearly a fifth (18.3 percent) of personal income in the United States, an all-time high, and this in a society with a relatively weak social safety net. 

In 2010, real wages stagnated—nominal wages increased 1.7 percent just slightly more than inflation.  The poor performance in wages can be explained by the fact that this has largely been a jobless recovery.   In February 2011, the economy did manage to add 192,000 jobs but the relatively good numbers for February follow months of anemic job creation.  In January, for example, the economy created just 63,000 jobs while 125,000 are needed each month merely to keep up with the growth of the labor market.  As of February 2011, official unemployment was still at 8.9 percent, with the broadest measure of unemployment, which includes discouraged workers and part-time workers by necessity, standing at 16.1 percent.   And civilian labor market participation continues to hover near a decades-long low of 64 percent.

Worse, the jobs that have been created during the recovery have by and large been relatively low-wage jobs, located mostly in the education and health care sectors of the economy.  And with the slow pace of job creation, wages are not likely to show any significant improvement any time soon, thereby eliminating the possibility of wage and income-led growth at least in the short term. 

The resiliency of consumption can also be attributed to the wealth effect created by rising stock prices in 2009 and 2010.  While wages have been stagnant, corporate profits have rebounded nicely.  That together with the Fed’s program of monetary reflation has resulted in a strong rebound in the U.S. stock market.  While equity prices have recovered most of their losses, housing prices have not.  The crash of the over-inflated housing market has disproportionately affected middle-income homeowners, who have much of their wealth invested in non-financial assets, such as homes.  While the S & P has gained more than 90 percent since its March 2009 low, housing prices have resumed their decline, and are threatening to break their 2009 low. 

Stagnant wages and falling housing prices hurt moderate and low-income consumers, while rising profits and stock prices have generally benefited upper-income individuals.  Thus, the lop-sided nature of the recovery has contributed to the return of inequality and the plutonomy economy—an economy characterized by wide disparities of wealth and income and driven by high-end consumption. Not surprisingly, nearly the entire gain in consumer confidence in recent months has come from the growing strength in sentiment in the top 20-percent income group.

On the positive side, there has been some improvement in the personal savings rate. Since the Great Recession, Americans’ personal savings have increased, in keeping with the need of private households to reduce their debt levels.  The personal savings rate has averaged 5.2 percent since the beginning of the recession compared to 2.2 percent in the two years prior to the recession.  That said, private household deleveraging still has quite a way to go.  Since consumer credit peaked in 2008, American households have been able to cut just $481 billion of credit, leaving households with debt levels that collectively stand at 91 percent of GDP, down just slightly from 96 percent when the bubble burst in late 2007.  But as debt in the household and financial sector has shrunk, public debt has increased.  Federal debt held by the public has grown from 36.2 percent of GDP in 2007 to 62 percent at the end of 2010.  Thus the economy has replaced private household debt with government sector debt.

iii. Global Rebalancing:  An Improvement in the U.S. Trade Balance

A new more balanced pattern of economic growth depends upon a strengthened tradable goods sector and a sustainable improvement in America’s trade balance.  In order to work its way out of the debt accumulated during this crisis and, at the same time, improve American living standards, the United States will need to produce more to be able to export more and import less.  Indeed, future economic growth needs to be driven less by domestic consumption and more by global demand in those economies that have under-consumed for much of the past decade.  

The economic recovery, however, has not seen any benefit from rising net exports or any sustained improvement in America’s trade balance.  The trade deficit did decline in the first months of the recession as U.S. demand plunged, hitting a low in May 2009.  But the trade deficit has actually expanded since then, rising from 3.6 percent of GDP in 2009 to 4.4 percent of GDP in 2010, and has thus acted as a drag on the U.S. economy.  Overall, net exports subtracted 0.5 percent from GDP growth in 2010.

The Obama administration has made doubling U.S. exports within five years one of its main economic policy goals, and while U.S. exports have grown in recent months, U.S. imports have also increased, as U.S. demand has rebounded and as energy prices have risen.  It will not be possible for the U.S. economy to meet the Administration’s export goal or to reduce the drag of the trade deficit without a more far-reaching rebalancing of global demand.  The best way to rebalance global demand would be for the large current account surplus economies like China and Germany to do more to stimulate domestic consumption, or in the case of China to allow its currency to appreciate.  But China has resisted any significant appreciation of its currency, and despite the rhetoric of its leadership, has been slow to implement measures to rebalance its domestic economy.

America’s energy policy has also continued to act against the goal of rebalancing global demand.  The administration has pushed clean technology and renewable energy initiatives but it has done so in such a way that has actually ended up subsidizing production in China and other economies.  As a result, America’s green trade deficit has actually increased in the past two years.  In pushing an ill-designed clean energy agenda that aimed for the wider commercialization of wind and solar, the administration has largely ignored other sources of energy, such as natural gas, that offered much bigger returns in terms of jobs and economic growth as well as deeper reductions in greenhouse gas emissions.  During this period, America’s oil import bill has increased, which in turn has contributed to the rising trade deficit.   

As noted earlier, the pattern of the U.S. economic recovery largely reflects Washington’s policy priorities not the rhetoric of the Obama administration.  The gigantic monetary reflation and Wall Street bailout, engineered by the Federal Reserve and the Bush and Obama administrations, including the second round of quantitative easing by the Fed, has led to a recovery of financial assets and profits.  But it has done very little to create jobs or to boost investment.  As a result, the United States is experiencing a pattern of economic growth (sans the housing bubble) that resembles the pattern prior to the financial crisis of 2008.

Recovery and Reform: Act II

From the beginning of the Great Recession, Washington policymakers have been pulled between the short-term imperative of rescuing the economy and the longer term need to reform and restructure the economy to put it on a new growth path.  In his State of the Union Address, President Obama pronounced the end of the recovery phase and the beginning of his administration’s program to build a competitive economy for the 21st century.  With the mid-term elections, the Congress had made a comparable pivot toward a new era of government austerity and an agenda of deficit reduction.

This pivot of the Administration and Congress to competitiveness and austerity, however, does not square with the economic realities.  Despite some encouraging signs, the recovery is still vulnerable to a worrying set of headwinds, including rising energy prices, the waning of federal stimulus, a double-dip in housing, continued high levels of unemployment and underemployment, and ongoing state and local government cutbacks.  One must add to this list the deflationary economic shock of the disaster in Japan, the ongoing sovereign debt crisis in Europe, and the risk of a slowdown in the emerging markets because of rising interest rates.  Indeed, the political and economic debate has mischaracterized the challenge ahead.

The real challenge is not how to cut public spending but how to support the economy as part of a transition to a new pattern of more balanced economic growth.  Put another way, the question is how to create a bridge to new sources of economic growth that would make possible more widely shared prosperity over the next decade or two.  The answer offered here is fourfold:  public investment in infrastructure and America’s quality of life, the stimulation of global demand for American technology and efficiency-enhancing capital goods as part of a larger effort to rebalance the global economy, the development of America’s considerable energy resources, particularly natural gas; and the restructuring of the health care and education sectors of the American economy to unlock future productivity gains. 

This program entails shifting demand from consumer goods to public and private investment aimed at improving America’s public quality of life and expanding access to quality education and health care.  It also means shifting demand from the consumer sector of the U.S. economy to consumers as well as producers in large emerging economies that have tended to under-consume over the past decade, which will boost the demand for U.S.-produced goods and services.

i. Public Infrastructure Investment

There are two areas of enormous pent-up demand on which a program to rebalance and restructure the economy can be based. The first and most important is the pent-up demand in the United States for public infrastructure improvements in everything from roads and bridges to broadband and air traffic control systems to new energy infrastructure. The United States needs not only to repair large parts of its existing basic infrastructure but also to put in place the 21st-century infrastructure for a more energy-efficient and technologically advanced society. If done properly, this project would entail several trillion dollars in new public and private investment over the next decade.

Public infrastructure investment of this magnitude would simultaneously meet several critical economic needs.  First, it would help fill the demand gap left by weaker consumer spending and by the drop-off in housing construction, and thus would help support the economy through this difficult transition period but in a way that lays the foundation for a more productive economy.  Indeed, public infrastructure investment is the best way to increase demand and investment at the same time.  Second, it would create millions of new jobs, and thus help move the U.S. economy back toward full employment within the next five years.  This in turn would help improve the wage outlook for American workers, allowing American consumers to pay down their debt while maintaining or even improving their standard of living. 

Third, it would make the economy more efficient and productive over the longer term.  The U.S. economy currently suffers from a number of infrastructure bottlenecks—traffic-choked roads, clogged ports, an antiquated air transportations system, an unreliable electrical grid--that cost the economy billions of dollars in lost income and economic growth.  Correcting these infrastructure problems is critical to the goal of laying the foundation for a healthier pattern of economic growth in the future.  In a globalized economy, public infrastructure investment has become more critical than ever to the competitiveness of the traded sectors of the economy.  Public infrastructure investment makes private investment more efficient and more competitive globally by eliminating many of the bottlenecks mentioned above and by lowering the cost of transportation, electricity, and other core business expenses.  Infrastructure investment is also essential to the development of new growth industries.  In fact, many of the new growth sectors of the economy in energy, agriculture, and clean technology require major infrastructure improvements or new public infrastructure.    

The question is not the need for a public infrastructure program but how to pay for it, given the already large fiscal deficits projected for the next five years and the general resistance to tax increases.  And here is where institutional innovation comes in.  If properly designed, a national infrastructure bank could leverage billions of dollars of private investment by tapping the private capital markets for public infrastructure investments.  For example, if properly capitalized, an infrastructure bank could leverage up to ten times its capital by issuing bonds to attract institutional investors and by using loans and loan guarantees to draw in private capital.  One model would be the European Investment Bank, which has successfully supported European infrastructure investment over the past several decades.  

ii. Global Demand for American Technology and Capital Goods

The other significant source of potential growth is the pent-up demand in China and other emerging economies for both consumer goods and the productivity-enhancing and energy-efficient technology needed to sustain both corporate profitability and rising living standards.  High energy prices, together with rising wages, are beginning to force those societies’ to increase productivity and energy efficiency. If successful, this shift would increase demand for U.S. goods and services, allowing the United States to improve its trade balance and remove a drag on economic growth. Increased world demand for American technology would in turn help spur new investment and, with it, a new generation of technological innovation.

This in turn would help bring about the much needed rebalancing of the global economy.  Ironically, higher food and energy prices may provide the catalyst for a realignment of global currencies and the rebalancing of global demand.   Higher food and energy costs are creating pressure on China and other Asian exporting economies to let wages rise in order to avoid political tensions. Higher wages would increase the purchasing power of Asian workers and augment consumer demand, which would help create a healthier balance between demand and savings in those societies. They would also force companies operating in emerging economies to seek out new productivity gains to compensate for rising wage levels. The drive for more rapid productivity growth in emerging economies would in turn increase the demand for labor-saving and efficiency-enhancing technology. This would benefit many American technology companies that supply software and networking equipment, as well as American companies that are developing cutting-edge technology to improve energy and materials efficiency.

To deal with the inflationary effects of higher wages as well as higher food and energy prices, China and other emerging economies have two choices:  they can either tighten monetary policy and raise interest rates or allow their currency to appreciate.  The latter is clearly the better alternative for both them and us.  By allowing their currencies to appreciate, China and other emerging economies can reduce the cost of energy and food imports since the price of oil and other commodities are priced in dollars.  And they can do so in a way that increases their purchasing power and thus their demand for America’s efficiency-enhancing technology and services.

Together with expanded public infrastructure investment in the United States, the transition to intensive, energy-efficient growth in emerging economies would greatly increase the demand for American-made technology, setting the stage for new investment in a wide range of American technology companies. U.S. companies still enjoy a competitive advantage in a range of technology areas, from aerospace to business software to networking. What has been missing in recent years has been a new demand catalyst to drive new investment and innovation.

Higher commodity and energy prices are also helping drive a new tech boom in other areas. In addition to benefiting many American producers, high commodity prices are setting the stage for new growth industries aimed at tapping scientific breakthroughs in agriculture, biotechnology, nanotechnology, the life sciences, energy extraction, and materials. The United States needs to position itself to take advantage of potential huge returns from new investments in the emerging growth industries of the triple green revolution: agriculture and biotechnology, clean technologies and energy and resource efficiency, and new energy sources.

In the area of energy and resource efficiency, rising commodity prices and concerns over global climate change are creating a huge demand for technology that can help make traditional industries more efficient and eco-friendly. Technology for squeezing more production out of existing oilfields, for example, is in great demand. So is technology for extracting minerals in a more environmentally friendly way. These same factors are also leading to a new cluster of clean technology companies, which specialize in technology to enhance energy efficiency and reduce carbon emissions.  As we are beginning to see, the demand for such engineering solutions has the potential to help create a rebirth in America’s industrial heartland, especially in the old mining and commodity belt of the Upper Midwest.

In order to fully capitalize on these technological trends, the United States needs a more conscious technology and competitiveness strategy that seeks to on-shore more manufacturing as well as research and design in the United States. A technology competitiveness strategy would lower the cost of doing business in the United States by providing better infrastructure and more skilled workers, eliminating the tax incentives for companies to move their operations abroad, and adding tax incentives for companies to increase investment and job creation in the United States.  With the right technology and competitiveness policies, the United States should be able to take advantage of the increased global demand for technology to spur investment in a cluster of new growth companies. In the process, it will be able to broaden the productive base of the American economy and create millions of new jobs that pay middle-class wages, helping to reverse the slow growth in wages that has held back living standards over the past several decades.

iii. An Energy and Energy Efficiency Mini-Revolution

While U.S. companies are among the world’s leader in energy-efficiency technology and in oil and gas services, the United States has yet to put these technological advantages to full use domestically.  Indeed, one of the glaring weaknesses of the U.S. economy is its vulnerability to high energy prices and its relative low energy efficiency, which during times of high oil prices raises the cost of doing business, cuts into discretionary consumer spending, and increases the trade deficit.  According to a study by IHS Global Insight, every 25 cents of a gallon increase in the price of gasoline—which is equivalent to a $10.70 a barrel increase in crude oil—results in a decline of .25 in annual GDP and the loss of 270,000 jobs.  In 2010, crude oil imports accounted for more than $250 billion of America’s trade deficit—or nearly 2 percent of GDP.  With the recent surge in oil prices, that number is likely to rise significantly in 2011.  Reducing the American trade deficit in oil by half would therefore add almost 1 percent to GDP.

As noted earlier, President Obama has made clean energy one of the centerpieces of his economic competitiveness program, and has rightly pushed measures to improve energy efficiency.  But also as suggested earlier, his program may actually be a drag on economic growth for the near and medium term.  This is so because the program subsidizes the commercialization of inefficient wind and solar technologies, many of which are produced abroad, while ignoring more efficient alternatives that would cut America’s oil import bill and reduce the overall cost of energy in the United States.  It makes no economic sense, for example, to subsidize the installation of imported wind turbines when natural gas fired generators can produce an equivalent amount of energy for one-third to one-half the cost.  Thus, the administration’s program may actually subtract from economic growth over the next 5 to 10 years.

The United States, of course, should invest heavily in research and development into new clean technologies with the goal of bringing about an energy revolution.  But in the short to medium term, it does not need to have an energy revolution to make energy development a new source of economic growth for the economy.  A mini-revolution will do, and that is exactly what the United States has enjoyed in the last few years.  Because of new technological advancements in oil and gas extraction, and because of new large oil and gas shale discoveries, the United States has dramatically increased both its natural gas production and its recoverable reserves.  The most recent estimates suggest that the United States has the natural-gas equivalent of more than 350 billion barrels of oil—roughly as much as the proven oil reserves of Saudi Arabia and Venezuela combined.  And because of the increased production and glut of supply, natural gas prices have fallen to less than $4 per million Btu, from an average of nearly $7 per million Btu in the four years between 2005 and 2008.  Wind and solar in the United States become competitive when natural gas is closer to $9 per million Btu.

What the United States does not have is a strategy to take advantage of its huge cornucopia of natural gas.  Natural gas has the advantage of both being able to lower the cost of energy and reduce significantly carbon emissions.  And it can be used directly for both electricity generation and transportation.  While there are some environmental concerns about the effect of some extraction techniques on drinking water, these problems have been shown to be manageable with proper regulation and oversight.  It is estimated that the United States could over a ten-year period cut in half its importation of OPEC oil by converting its heavy transportation fleet of trucks and buses to natural gas.  The other advantage of developing America’s natural gas resources is that it would create jobs and manufacturing in the United States since much of the equipment used to extract and transport natural gas is made in the United States by American companies.  It is also possible that the United States will become a major exporter of liquid natural gas over the next decade given the price differential that exists between domestic gas and that produced abroad.

iv.  Unleashing Productivity Gains in Health Care and Education

Productivity growth is the key to rising living standards and to economic growth.  Over the past decade, America’s productivity growth has been reasonably strong, growing at more than 1.6 percent annually.  But it has been highly concentrated in a few sectors:  manufacturing, computers, and retail. In order to be able to sustain productivity growth and thus rising living standards, the United States needs to extend productivity gains into other sectors, especially in health care and education, which account for a growing share of the U.S. economy.  Even relatively small gains in productivity in those sectors can yield sizable reductions in cost and improvements in living standards.

As it is, productivity bottlenecks in heath care and education threaten to constrain future productivity growth as the size of these sectors grows and as their poor performance weighs on other sectors of the economy.  Already, American-based companies are at a competitive disadvantage because of the exorbitant health care costs and because American educational institutions are doing a poor job of preparing workers for the productive economy of the 21st century.  Even if the government were to relieve American-based companies of the burden of providing health insurance, that would just shift costs onto individuals or onto the government without an overhaul of the system to make it more efficient.

By the standards of other advanced democracies, the U.S. system for providing health care and education are considerably inefficient.  U.S. health care now consumes more than 16 percent of GDP but delivers below OECD-average health care in terms of infant mortality and life expectancy.  And the United States spends more per student at the K-12 level than almost all other democracies, yet American students perform in the lower half of most international tests.  Furthermore, the cost of college tuition has risen by more than 60 percent over the past five years, pricing many young people out of a college education.

Both the health care and the education sector suffer from a cost disease, caused by the fact that they are organized inefficiently, often along old craft lines, and have not taken full advantage of the information technology revolution.  Agriculture and manufacturing, too, were once organized along craft lines with a few highly skilled specialists at the top and with many low-skilled workers at the bottom.  But a process of capital deepening and technological innovation transformed these industries into more productive middle- to high-wage sectors of the economy.   

While health care and education may never be as productive as agriculture and manufacturing, a similar combination of capital deepening, technological innovation, and re-skilling could significantly improve productivity in these and other quality-of-life sectors, so that they employ greater numbers of moderately-paid workers with middle level skills.  Creating more middle class jobs would not be the only advantage of this approach.  If the health care and education sectors of the economy could be restructured to improve productivity, it would help lower the cost of these essential quality-of-life services.  It would therefore also be a way of improving the real compensation of American workers without increasing their real wages. 

For these reasons, U.S. policy must promote a quality and efficiency revolution in both the U.S. health care and educational systems.  Government policy should begin with incentives to make better use of information technology in both the health care system and in U.S. schools and universities.  As evidenced by the turnaround within the Veterans Administration hospital system, the digitization of medical records, together with the use of evidence based medicine, would bring some immediate productivity gains.  So would the expanded use of telemedicine. 

A similar reform and restructuring approach will need to be applied to education, and not just at the K-12 level.  The greatest future quality and productivity gains may occur in higher education, where costs are rising most rapidly and where there are the most opportunities to make greater use of information technology to reduce costs and accelerate learning.  For example, studies suggest that after a certain age students learn more effectively with interactive computer programs than they do in standard teacher classrooms.  This finding could revolutionize higher education and lower overall tuition costs at American colleges and universities.

A New Trans-Atlantic Agenda

One of the advantages of the proposed new economic growth agenda for the United States is that it would be generally complementary to Europe’s own effort to reshape its economic growth model to emphasize smart, more inclusive, and more knowledge-intensive economic growth.  American efforts to upgrade its public infrastructure and restructure its health care and education systems would have little direct effect on Europe’s own economic development while having considerable beneficial indirect effects for the larger global economy. 

Similarly, the proposed energy program for the United States would permit a complementary division of labor, with Europe able to concentrate on its expertise in wind, solar, and other renewable energy sources, while the United States focuses more on natural gas in part because of its considerable domestic resources.  This in turn may permit the two continental economies to pool their resources on research and development for the future.  And while there will naturally be some fierce competition for world markets in certain advanced capital goods and knowledge industries, there is the potential for developing reciprocal trade relations to arrive at balanced U.S.-EU trade and to preventing harm from some of the worrisome features of China’s indigenous innovation initiative.

The general complementary nature of new economic growth paths for the United States and Europe would free attention away from managing Trans-Atlantic tensions to creating a better coordinated Trans-Atlantic global reform effort.  High on that list must be a better coordinated effort to deal with the trade and industrialization practices of China and to manage the impact its growth model has on the rest of the world.  The United States and Europe have both an economic and foreign policy interest in ensuring that China becomes a more balanced economy that depends more on domestic demand.   As it is, China has too often been able to pit the United States against Europe, forcing the U.S. and Europe to compete over limited global demand.

If Asia, in general, and China, in particular, remains committed to continuing its decades-long practice of running current account surpluses, then either Europe or the United States will have to give in its effort to restore growth and improve employment conditions by tapping external demand.  While the European Union may be in a better position to pursue an expansionary domestic demand oriented growth program given the relative strong fiscal positions of Germany, France and the Netherlands, the question of who gives is likely to be determined ironically by who ends up having the strongest currency.  A stronger currency will make export-led growth more difficult for both the United States and the core European economies as they compete in the short term for each other markets and for competitive advantage in Asia.  For this reason, both Europe and the United States have an interest in seeing a larger realignment of global currencies with reform of both the Eurozone and the dollar zone (in which China and other Asian exporters in effect peg their currency to the dollar, thereby preventing trade adjustment.)

Similarly, both the United States and Europe have an interest in seeing that China does not continue to crowd out economic growth in both of their neighborhoods.  By dominating world manufacturing at both the low and middle rungs with its low cost labor and an undervalued currency, China has made it more difficult for countries in the EU-Rim (Eastern Europe and the Balkans and northern Africa and the Middle East) and the U.S.-Rim (Mexico, Central America, and the Caribbean) to develop their manufacturing base.  As a result, these regions suffer from high levels of unemployment and underemployment, and have become foreign policy burdens for the European Union and the United States.   

If China and other Asian economies persist in this pattern of adversarial trade, then it may be necessary for the United States and Europe to develop a more common front against Asian mercantilism to defend their middle class way of life.  Such a common front might also include as suggested here a commitment to a Trans-Atlantic Keynesian project to expand public investment and social quality of life spending in both Europe and the United States and to develop the Rim of emerging economies along the European Union and North America.  Such a program would clearly benefit the working and middle classes of Europe and the United States.  It would also be in the interest of the aspiring middle class in China since as noted earlier China needs to rely more on domestic demand for future economic growth than it does now.  Neither the political leadership of Europe nor the United States is currently thinking along these lines.  But it may be time for them to do so.

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