Why the American Economy Might Never Get What It Needs

The last of this year’s big elections are a few months away, and they will be the biggest one to watch as always. This is because what happens in America affects the entire world, especially on the economic front. The country is not only the world’s largest economy, but one with the largest influence in terms of footprint around the world. Besides, with the US dollar being the reserve currency and the one in which most trade around the world is conducted, every move of its value affects currencies, trade and the economy everywhere else.

Politically too, America has played a huge role in international matters, especially since the Second World War. It likes to see itself as statesman to the world, though its role in practical terms has really been more as policeman. And it has always been in a power tussle of sorts ever since WWII, first with the Soviet Union for decades and is now in the initial stages of one with China. The two kinds of Cold War as I like to call them are of very different kinds. If the one with Soviet Union was ideological, and involved military expansion and competition, the one with China is economic and fuelled by technological competition. I suppose it is sign of the times we live in.

There is yet another way in which America manages to influence the entire world and one to which least attention is paid. The way its capitalist economy works through the private sector, has led to a history of technological innovations that few other countries can match. Until, China emerged on the international stage, that is. And this is an important reason why America feels compelled to engage in an eco-tech war with China, which it sees as a real challenger.

Unfortunately, the capitalist system in America works to reward itself, not for the benefit of the common good. And this is where the American economy differs most from the European ones, where capitalism is made to work within the framework of social democracy in most countries. One can argue whether unfettered capitalism leads to better and more innovation; those who believe it does must also accept that technological innovation replaces human beings at work. And that much of America’s problems with loss of jobs is due to the pace of technological change and innovation. Actually, if one looks at the unemployment numbers, they have historically been higher in Europe, than in America, but this could also be because fewer people in America are even looking for jobs.

In one sense, it is good that America continues to innovate at the pace it does, considering it is in a slow growth phase, as most advanced economies are. On the other hand, it takes a toll on people and on society, and this is what the US economy isn’t geared to tackle. In this context, politicians in America find it very easy to play on people’s fears and insecurity in order to extract political mileage for themselves. They blame it all on globalization, but conveniently forget that it is their own home-grown technology innovation machine that is jeopardizing the future of their countrymen and women. They would rather let the machine roll on at whatever pace, than apply their minds to how to regulate it better and benefit more people on a sustainable basis.

Looking at the current scenario, the US economy is slowing down from its post-pandemic highs, but not slowing down enough for any of the presidential candidates to make a political campaign out of it. In fact, most economic data emerging from America recently seem to point to a strong and resilient economy, including the consumer, and the slowdown will only help the Federal Reserve bring down inflation sooner. A soft landing is what most commentators have been talking about, though the weak jobs numbers of July seem to have brought back fears of a recession. Jitters, at any rate.

This recent economic performance has kept the candidates somewhat silent on the economy, or so it seems from the news reports on the election rallies in the US. This, when most polls suggest that the average American is concerned about inflation and the economy. But politicians would be terribly mistaken to not see the warning signs flashing: high fiscal deficits of 7% and a US $26 trillion mountain of debt, 107% of GDP. One would have thought that after the Covid-19 pandemic, America would have pared down its fiscal deficits to more reasonable levels. Hard to do when you have given generous corporate tax breaks that helped the wealthy more than the middle-class. And when the US government under Biden’s regime also thought it important to build capacity through infrastructure spending, the CHIPS Act and the IRA, all of which means additional spending of US $2 trillion over the next 10 years.  

If these capacity-building measures keep the US economy growing at a steady pace for the next 5-10 years, they will also tend to keep consumer price inflation at elevated levels for the foreseeable future. Having made a sudden change of candidate at the eleventh hour, the Democrats have had to quickly cobble together an economic plan that appears to mostly remain the same as Biden’s. With increases in the corporate tax and on the wealthy, and tax relief for the middle class mainly in the form of an expanded childcare tax credit and making it easier for them to buy homes. I think both the latter plans are more political, aimed at garnering votes, and not sure how they help the state of America’s public finances.

There is plenty to worry about as far as the Republicans’ economic plans are for a second Trump term. And economists are right to express their reservations about them as well.

First, is Trump’s plan to raise tariffs on Chinese imports to 60% and on all other imports to 10%. This article from AEI on the subject correctly analyses the problem to be with Trump’s obsession with America’s trade deficit, and it is true that this will only make most goods more expensive for American consumers. Besides, ruining trade and economic relations with countries across the board.

Next is his plan to weaken the US dollar – bizarre as it sounds – which is reported to be his VP candidate JD Vance’s idea. I suspect this too comes from Trump’s obsession with the trade deficit, and he probably thinks that America can export its way out of a large trade deficit. In this article by economist Kenneth Rogoff in Project Syndicate, he writes about the problems with such a wish for a weaker dollar. The lowering of interest rates by the Federal Reserve over the next couple of years will weaken the US dollar slightly, but not by much. I wonder how Trump can actually manage to weaken the dollar, when its strength comes from the strength of the US economy and the huge investment flows into the country. Will he actually impose a capital control tax of some sort?

Then, there is another equally bizarre idea of Trump’s to replace taxes in the US with tariffs. I can’t believe he has articulated such an idea anywhere but going by the former two ideas, the third can’t be ruled out, I suppose! Economist Maurice Obstfeld and a colleague have written for PIIE (Peterson Institute for International Economics) on whether Trump can actually replace taxes with tariffs and what that would mean for the US economy.

And finally, we have Trump and his allies going for the jugular. They intend to reduce the Federal Reserve’s independence in setting monetary policy. Wall Street Journal was the first to report this, but since it’s paywalled I read about it on Reuters and Axios. I don’t know how they can manage this, except through legislation and this would set America on a treacherous path of politicised economic policymaking.

From reading all this, I think American citizens have plenty to worry about and every right to be concerned. And yet, from watching the news on CNBC or CNN, you wouldn’t think so, because they focus little on what the implications of any of these ideas would be on the American economy. The reports of various political rallies are just the usual rallying to the public; pardon me for saying so, but it appears thus far that the US elections are nothing more than summer games!

If one were to look at the hard facts, there’s CBO’s Long-Term Budget Outlook 2024-2034 and 2024-2054. These tell you the precarious state of America’s finances in terms of revenue and expenditure, and where the borrowing and spending is the most. It is not just American households who live beyond their means, the entire economy functions that way and it is obviously not sustainable. Or is it, because theirs is the reserve currency and they never have to worry about balancing their budgets? Neither of the presidential candidates have made clear to the voters how they plan to fund all this future growth, and what voters can expect from the new administration.

I suppose it is the current strength of the US economy that is responsible for the candidates’ complacency. But they would be mistaken not to see the flashing warning signs, as I said earlier. And even irresponsible, to think they don’t owe their voters an explanation for how they will better the economy, especially when we see federal government’s fiscal deficits and debt of the order as indicated in the charts above.

Here’s what I think the American economy badly needs, in order to grow sustainably for the really long-term. First, given their ageing demographic and the rising healthcare spends, America seriously needs to bring down its healthcare costs. It is reported that the US spends 18% of its GDP on healthcare with poor consequences, and this must change. They need legislation to cap the prices of certain essential drugs, though I can see how the big pharma lobby in the US will resist it with every breath in its body. When one looks at the monthly CPI numbers, there too, it is healthcare prices that are persistently high.

Next, related to high healthcare costs, is the rising Medicare expenses which typically go to the elderly in America. I think the eligibility age for Medicare coverage ought to be raised, as most of them are Baby-boomers who are well-off and in good health. They tend to form the biggest spending consumer cohort in America, including on travel. Surely, its time Medicare benefits went to the more needy among the elderly and the US federal government pares down its expenses. If necessary, spending on Medicaid, medical assistance to the poor in America, can be expanded.

And finally, the old subject that keeps returning to the economic agenda, because it never gets accomplished. Tax reforms. Not tax cuts, but tax reforms in the real sense of the term. Just as important as entitlement reforms, in my opinion. I am glad to hear that Biden was planning to raise corporate taxes from 21% that Trump had lowered them to in his first term, to at least 25% though I think 28% would be even better. I hope Kamala Harris is sticking to this plan, whatever else she intends to do. And I think income taxes on the highest incomes ought to be raised by a reasonable amount. However, to achieve real tax reform, the US would have to get rid of a lot of the exemptions that currently complicate the tax system more than necessary. So that the country’s tax system can truly be as progressive as it claims to be.

These are the tricky areas that the American economy avoids confronting face to face. And they continue to be stumbling blocks in America’s growth, because corporate America and policymakers have always been in a powerful vested-interest-lobby clinch. They think they need each other more than the country needs them. And over time, policies that exacerbate the inequalities in American society and increase divisions between people get entrenched. I must mention here, that it was good to see middle-and-lower income groups in America benefit most through the post-Covid recovery period, through higher minimum wages and better wage negotiations on the part of workers and employees. This is a rarity in America and I only hope this continues on a more sustained basis.

I think it’s time America’s politicians focused on setting their own house in order and quit worrying about other countries such as China or anyone else. Instead of starting another trade war and impacting the entire world, it might help to focus on reforms – both taxes and entitlements – that the ageing and rich superpower badly needs.

The featured image at the start of this post is of New York City by Isaac Sloman on Unsplash  

This article originally appeared on my blog on August 22, 2024.