We Know How to Fix the Economy -- We Just Won't Do It

Last Updated Nov 5, 2010 2:54 PM EDT

The day after an election that is supposed to change the political landscape, the Fed announced another round of Treasury purchases in an attempt to jolt the economy into hyperdrive. I guess no one told Ben Bernanke that we're going to do things differently from now on.

The big surprise of the election's aftermath, viewed from the perspective of the economy and business, isn't just that the Republicans don't have a bold new vision -- unlike the ruling coalition in the UK, there's no serious talk of austerity. It's that there's such a broad gulf between what the electorate seems to want -- no taxes, a smaller deficit and more services -- and what the experts all agree needs to happen.

Taking a blunt instrument to the economy
That gulf has left Chairman Bernanke with no other option but QE2, a highly risky strategy designed to force businesses to spend rather than risk making no money -- or seeing it erode through inflation -- by holding cash. In other words, Bernanke is wielding a very blunt instrument. The chances of his breaking through the problem without causing all sorts of undesirable damage are pretty slim.

What the U.S. economy needs is a more surgical solution. Surprisingly, the problems facing the American economy are vast but relatively simple to understand. Mohamed El-Erian put it well in the Washington Post on the day after the election:

For too many segments of our society, the ability to spend and hire is constrained not by questions of willingness but, rather, by stubbornly high unemployment, annihilative debts and, in some cases, concerns about losing one's home. As a whole, the United States is still overcoming the legacy of years of over-leverage and misplaced confidence that consumption can be financed by borrowing rather than earnings. The resulting debt overhangs act as strong headwinds to growth and employment generation.
This public and private debt is the single biggest limitation on the American economy. Paying it off has strangled industry and starved government of tax revenue. The debts come in several forms. One type of debt is mortgages. The government owns them, and the houses those mortgages financed are no longer worth what the owners paid for them.

Either way that contradiction is resolved -- by default or resetting the value of the mortgages -- the U.S. government will lose money.

Rising U.S. obligations
The far bigger form of that debt are obligations of the federal, state and local governments. State and local workers have good pensions and medical care. The federal government has made commitments to every American in the form of Social Security and Medicare.

We're all familiar with the ways in which pension and healthcare benefits hobbled the U.S. auto industry. The nation faces a similar problem. How to throw off the yoke of these rising costs? As we just saw, the only way GM could resolve the problem was through a true Hobson's choice: its workers could either accept a reduced contract or not have jobs.

Can the Republicans credibly offer the same choice to the entire American population? Accept a higher retirement age and bear more of the burden of your own healthcare or...? What? What exactly will John Boehner and Eric Cantor threaten voters with to get them to accept meaningful reductions in entitlements? The Democrats certainly weren't going to do that.

Needed: More and better infrastructure spending
Setting the debt aside for minute, the other challenge facing the U.S. is a lack of jobs. Why are there no jobs when the stock market is booming? Well, on reason is that nearly half of the S&P's profits are coming from overseas. That's where the growth is. Even with exports growing, excess capacity in American industry is at record levels.

Businesses are not hiring in the US because they don't need to. With domestic demand down because of the debt overhang, there's only two ways to generate job growth a massive jump in exports or big domestic infrastructure projects.

Of course, spending on infrastructure is something the Republicans campaigned against and the Tea Party abhors. However, the defense budget is a mind-boggling $717 billion dollars. One of the unpleasant truths of the American economy is that we provide employment and subsidize domestic industry through the Defense Department.

The Pentagon has created some very valuable infrastructure in the past. Most famously, it built the Internet that eventually set off the digital revolution. We don't really have the luxury of hoping lightning will strike again. So maybe the new spirit of cooperation that Obama touted during this week's press conference could be applied to restructuring the defense budget to reduce it and divert part of it toward serious infrastructure projects.

Obama's stimulus wasn't enough
The problem with Obama stimulus was that it was a stop-gap, not a stimulus. Money was used to prop up state and local governments. Just look at the choice New Jersey governor Chris Christie was forced to make between using state funds to pay benefits or fund a tunnel that would add to economic growth. He couldn't do both so the tunnel had to go.

That can't go on forever. It won't leave anything tangible behind. But government investment in old and new technology to improve transportation, reduce costs and increase competitiveness will be money well spent.

All of these efforts fit in with Republican goals and Tea Party rhetoric. Of course, there's one other thing that everyone agrees must happen -- eventually we'll need to raise some revenue through new taxes -- that we know the Republicans won't embrace. But that's really an issue for another time.

In the short term, the answers aren't very difficult to find. They're just hard to back up with a political support.

Image of John Boehner courtesy of GOPleader via Flickr