The New New Normal

Escape Velocity

The president's State of the Union address is the best place to focus responsibility and re-launch the American economy. Because the real problem is Washington. 

President Barack Obama's State of the Union address offers a unique opportunity to address the key economic issues of our time. And the American people deserve no less. It's been too long since the country was given an explicit and realistic assessment of where the economy stands -- identifying what needs to be done to enhance economic and financial outcomes and assigning responsibility where it belongs.

The U.S. economy continues to heal steadily after the trauma of the global financial crisis that landed it in the economic equivalent of a hospital's intensive care unit. It is generating jobs, fiscal and external deficits are narrowing, inflation has been contained, and disruptive cases of extreme financial vulnerability (including housing and banks) have been addressed. The patient has been released.

Yet the economy exited the hospital with structural impairments. As such, it can walk but it cannot run.

The country's growth dynamics remain overly tentative, with the latest estimate for the final quarter of 2012 suggesting a mild contraction (though the revised numbers should be a lot better). Annual growth rates are mired in the 1.5-2 percent range, well below the economy's expansion potential. And this morning's small business survey confirms that a powerful driver of growth -- and one that is key to the wellbeing of the middle class (and politics) -- is stuck in first gear.

Yes, jobs are being created, but not enough to bring unemployment down from its current 7.9 percent to the historically more acceptable level of around 5 percent. Too many people are what's known as "long-term unemployed" -- 39 percent of those officially out of work, to be exact. And a growing number of Americans are depending on, and in some cases falling through, the country's overly stretched safety nets.

Simply put, as hard as it tries, the U.S. economy is yet to attain economic escape velocity. As long as it remains bound by this additional gravity, middle- and lower-income households will find it hard to prosper, income and wealth inequality will increase further, and the economy will continue to struggle with a combination of persistently sluggish growth, unusually high unemployment, and worrisome pockets of poverty and deprivation.

Four issues, and ones I hope the president will address this evening, would contribute to the U.S. economy reaching this escape velocity:

1. At the macro level, the economy needs to transition from "supported growth" (which requires ever-more experimental and untested Federal Reserve policies) to "endogenous growth" (powered by more sustainable and less distortive engines).

2. At the sector level, improving the functioning of the labor market, education, housing finance, credit intermediation, and infrastructure renewal.

3. At the micro level, engendering private sector confidence that would unlock the trillions of dollars in cash that -- rather than invested in new plants, equipment, and hiring -- continue to lie idle on balance sheets and in bank's excess reserves.

4. At the financial level, replacing the blunt spending cuts associated with the sequester with a more thoughtful approach; and, agreeing on a medium-term framework that puts an end to merry-go-round budgetary negotiations that unnecessarily add to uncertainty and further political polarization.

By speaking directly to these issues, Obama can constructively reset the economic narrative at the very start of his second term. And in doing so, he would also help citizens reconcile three emotions that run high in America today: excitement, hope, and anxiety.

Many people are excited by how the impressive rally in financial markets has improved their 401Ks, their pension savings, and their investments. They are hopeful that, unlike the last few rounds of ups and downs, this rally will be validated by strengthening economic fundamentals. But they also remain anxious, worried not only about political dysfunction in Washington but also companies' hesitancy to invest, hire, and expand.

Tonight, in addressing what needs to be done on the economic front, the president can reassure citizens that America remains in full control of its destiny. Unlike struggling countries in Europe and elsewhere, it does not depend on the goodwill of others; nor does it face any immediate financial vulnerability.

The president also has the opportunity to make the point that what holds back prosperity today has less to do with traditional economic engineering and more with congressional politics. Indeed, while economists may differ on the precise details of an optimal policy package, there is little disagreement on the ultimate policy objectives and the related need for simultaneous progress on growth-enhancing structural reforms, demand management, and medium-term fiscal sustainability.

Which takes us from the "what" to the "who."

In addition to setting out where the economy stands and what it needs to go forward, Obama should not hesitate to remind the nation how dysfunction in Washington has repeatedly derailed sensible economic initiatives. From jobs to housing, many helpful reforms have fallen victim to extreme political polarization and endless election posturing.

As a rule, substance has repeatedly given way to trifling tactical maneuvers. Even the most basic economic governance responsibility -- that of passing an annual budget -- has eluded Congress for four straight years now. More generally, the sense of common purpose and the anchor of national unity have been replaced by rancor and pettiness.

By setting out a clear vision of what the economy's traditional vibrancy and innovative spirit is capable of, the president can place the required policy measures in a powerful context and assign implementation responsibility to those elected for that purpose. In the process, he would better align politicians' incentives, as well as use popular opinion for stronger congressional accountability -- a powerful tool in this digital era of social media.

The State of the Union address will hopefully be remembered as an important step in starting to overcome the gridlock that has undermined for too long the dynamism and entrepreneurship of the largest economy in the world -- a logjam that has come at a considerable cost to society.

I come to this conclusion as an economist that follows closely data and policy discussions, and as one that is hopeful that good sense and national duty will ultimately prevail on Capitol Hill.

But I am also saying all this as a parent. The longer it takes to shock Congress into a more constructive operational mode, the higher the risk that our children's generation will be worse off than that of their parents.

Alex Wong/Getty Images

The New New Normal

Getting Down to Business

The bad news is Washington hasn't seen the last of its bickering, dithering, and gridlock. The good news is Obama can change that in his first 100 days. 

For most of 2012, it was fashionable to characterize the U.S. presidential election as one of the most defining events in recent times. Certainly, if you happened to live in Florida, Ohio, or another battleground state, you were barraged with advertisements announcing that choosing one or the other candidate would result in the end of days. Amid a hotly contested and often bitter campaign, the presidential candidates went out of their way to highlight their differences, by exaggerating not just the good that each would deliver if elected but also the bad that the other would impose.

Now it's time for a reelected President Barack Obama to govern. First, though, a hard truth: As he thinks about his new presidential term, Obama will soon realize that, even if the spirit is willing, he will be unable to meet many of his election commitments. There is no rapid way to reverse the multiyear decline of America's middle class and no immediate way to pull up the poor who have fallen through the country's stretched social safety net. This inconvenient reality needs to be internalized quickly.

The United States' economic and financial situation provides Obama a limited degree of freedom, and a less-than-accommodating global environment adds to these constraints. Combine this with the reality of a divided Congress -- where too many elected officials have made personal pledges to oppose any and all taxes, a vow inconsistent with the country's current circumstances -- and what transpires is an uncomfortably high probability of continued bickering, dithering, and gridlock.

So rather than surging ahead with promised new initiatives, the incoming Obama administration risks ending up in the same political paralysis that dominated Washington the last few years. Think a world in which the U.S. economy's expansion stays sluggish, joblessness remains high (especially among the young and the long-term unemployed), income and wealth inequality continue to worsen, and deficits and debt continue to rise. Further political polarization and fragmentation in Obama's second term would reduce the likelihood of getting any good policy out of Washington, accentuating what has become a depressingly familiar and increasingly vicious cycle.

That's the bad news. The good news is that it need not be like this. In his second first 100 days, Obama has an unprecedented opportunity to right a fragile global economy and change the way Americans -- and the world -- think about Washington.

The steps fall into two broad categories: first, to limit and, if possible, remove the headwinds undermining economic success (in other words, do no harm); and second, increase the tailwinds (do outright good).

As for the headwinds, Obama's first challenge -- on full display this week during the flurry of deal-making on Capitol Hill -- has been to remove the "fiscal cliff" threat of automatic tax increases and spending cuts. The economy cannot absorb a disorderly fiscal contraction of some 4 percent of GDP without falling into another recession. Going over the cliff would increase unemployment and erase some of the hard-earned balance sheet cleanups of recent years. By exploiting common political ground with his Republican opponents, however, the president can limit the fiscal contraction to some 1.5 percent of GDP, which could also help set up longer-term fiscal reforms.

Second, the official narrative on China needs to pivot away from election-season bashing to constructive dialogue. The basic challenge is to enable discussions that minimize the tensions inherent between an established power and a rising one -- and in a way that underpins regional stability. To this end, Obama will need to reach out to the new Chinese leadership, walking back the dialogue from a single-issue focus (the exchange rate) to broader economic governance issues.

Third, the new administration needs to do more to help solve Europe's debt crisis. Another few rounds of public lecturing will only irritate European policymakers more. What's needed is meaningful progress in better harmonizing differences in regulation. In this effort, Obama needs to work with Europe above all else on giving emerging markets a meaningfully bigger say in the actions of the IMF and the World Bank.

Fourth, and most importantly, the new administration must be brutally honest with the American people about the multiyear, multidimensional nature of the United States' economic and financial challenges. After all the promises of the election cycle, Americans need to better understand the scale and scope of the problem. Obama needs to speak directly to the people and then appoint a specialized spokesperson to ensure that citizens and markets understand the president's economic vision and its implementation.

Once a better system of communication is in place, it's time to work up some tailwinds. Obama needs to initiate a reform effort that touches on four key areas -- and do so in way that 1+1+1+1 equals much more than 4. And it can.

He should begin by appointing a "jobs czar." If ever a national economic challenge required a person empowered by the president to break intra-agency blockages, America's unemployment crisis is it. Dealing with the malfunctioning labor market is one of the absolute top priorities. A stubbornly high joblessness rate -- and one that has disproportionately hit the young and long-term unemployed -- has turned a demand-deficiency problem into an increasingly structural one. America also needs aggressive labor retooling and retraining programs while making education more relevant to today's rapidly changing world.

Second, Obama needs to restart quickly the dialogue on medium-term fiscal reform. The election narratives suggested that a partial approach is possible by focusing primarily on just one side of the budget or the other. Don't believe it. The math indicates that there is no sustainable reform -- one that combines long-term debt sustainability, growth-enhancing realignments, and fairer burden-sharing -- without addressing both revenues and spending. And that begins with resurrecting the Simpson-Bowles debt-reduction plan to provide the initial analytic framework for a political compromise.

Third, there is no escaping the reality that lending will continue to be constrained as regulatory and market pressures force the banking system to deleverage further. Yet the financing of small business that Obama championed on the campaign trail should not be held hostage to banks' risk-averse behavior. Instead, Obama needs to initiate and lead a process of building alternative credit streams, some financed by the private sector for, say, working capital, while other things like infrastructure can be funded with public-private partnerships.

Finally, Obama needs to address the persistent problems in housing, a sector critical to the well-being of citizens, labor mobility, and stable wealth accumulation. The good news is that this market is stabilizing; the bad news is that a full recovery will not occur without principal forgiveness and difficult decisions about allocating losses.

This may seem an ambitious to-do list. But there's an ambitious amount of work to be done to correct years of excessive leverage, poor investment, an entitlement mentality gone crazy, and a risk culture gone haywire. Obama might not be able to claim an overwhelming electoral mandate, but a proactive administration with a clear agenda can lead a fragmented, discredited Congress toward greater collaboration. Anything short of this will condemn our children's generation to being worse off than our own.

Dennis M. Sabangan/EPA