THE VEIL OF UNCERTAINTY:
WHAT NEXT FOR THE WORLD ECONOMY?

Edward P. Lazear, Jack Steele Parker Professor of Human Resources Management and Economics, Stanford University Graduate School of Business; Morris Arnold and Nona Jean Cox Senior Fellow, Hoover Institution, Stanford University; and former Chairman, Council of Economic Advisers, Executive Office of the President

Event Summary by Richard C. Longworth, Senior Fellow, The Chicago Council on Global Affairs

Edward P. Lazear 

The United States is stuck in an inadequate, slow-growth recovery and it is “almost impossible” for government spending to restore real vitality, Edward P. Lazear told the Chicago Council Tuesday evening. 

Lazear was chairman of the Council of Economic Advisers under President George W. Bush. A former professor at the University of Chicago, he is now a professor at the Stanford School of Business and a senior fellow at Stanford’s Hoover Institution. He spoke to an audience of about 320 persons on the Council’s Global Economy Series. 

Lazear said that, by recent historical standards, the slowness of the nation’s recovery from the 2008 fiscal crisis is unprecedented. Since 1947, he said, the U.S. economy has grown by a steady 3.3 percent per year -- sometimes more, sometimes less, but not far from this standard. Even past recessions led to strong growth, restoring the economy to that 3.3 percent norm. 

Not now, he said. Economic output dipped sharply between 2007 and 2009. Recovery began in late 2009, but growth since then has been an anemic 2.2 percent per year. This means the economy is not catching up to that 3.3 percent trend but is actually falling behind: the gap between the normal trend line and the current situation is “diverging,” he said. 

The question is why, and what to do about it – or rather, what not to do about it. 

Lazear granted that this is the worst recession since World War II “but not by very much.”

Most economists cite work by Carmen Reinhardt and Kenneth Rogoff showing that recoveries are always slower from recessions caused by breakdowns in the financial system. That cause doesn’t apply now, Lazear said, because “the magic of the Bush Administration in the fall of 2008” kept big financial institutions alive and prevented such a breakdown.

The real problem, he said, is that the Obama Administration’s policies on taxes, regulations, trade, and fiscal balance have stymied business and slowed growth. Any attempt to tie recovery to increased government spending, he said, is doomed. He asked if we can we spend our way out and answered that this is “almost impossible.” 

Using a combination of algebraic equations and plain English, Lazear explained why. Growth in gross domestic product (GDP), he said, is the sum of the growth in consumption, investment, government spending, and the trade surplus. If this rate of growth is to increase, then growth in one or more of these factors must first increase. 

This accords with Keynesian economics, which says that, in a recession, government should stimulate the economy by increasing spending. But Lazear said this is a short-term and insufficient boost. 

He said that an increase in government spending from, say, $2 trillion per year to $2.5 trillion would give the economy a $500 billion boost. That indeed would increase the growth in GDP – but only for that year. For this rate of growth to stay high, the government would have to keep on spending $500 billion more, year after year: otherwise, the rate of growth stalls. 

No government “can do this forever, which is why this is almost impossible,” he said. 

Lazear implied that this is the story of the Obama Administration’s early stimulus – a one-time boost that can’t be repeated. Any new stimulus would only lock the government into an unsustainable commitment to never-ending spending increases.

This slow growth has human fallout, in unemployment, Lazear said. Economics teaches that every one percent increase in GDP reduces unemployment by a half of one percent – and that’s happening now, he said. The trouble is that slow growth: if the economy is growing only 2.2 percent per year, this reduces unemployment by about one percent, and that’s not good enough.
 
“It’s not a structural problem,” Lazear said, “but a problem of low growth.” 

What’s the solution? Not increased debts or deficits, he said: the nation’s deficit already is growing at a Mediterranean clip. Nor higher taxes: any tax increase that met proposed government spending would end up raising middle-class taxes by 50 percent. 

Besides, higher taxes would retard business spending, he said. Businesses now are less concerned with uncertainty over the fiscal cliff than “the likelihood that there’s going to be a tax structure that is not pro-growth, pro-business, pro-jobs.” 

What’s needed instead, he said, are a “pro-growth tax policy,” more openness to trade, a “more sensible regulatory policy, with cost-benefit analyses,” and “fiscal responsibility.” 

“If we don’t get our debt in order,” he said, “we’re going to be where Italy is now.” 

Nothing else will work, Lazear said. Higher living standards depend on higher productivity, and higher productivity depends on technological change, which in turn depends on investment. Only a return to pro-growth policies will lead to higher investments. 

The Chicago Council on Global Affairs seeks to foster civil and informed discussion of foreign policy and global issues. Views expressed in event summaries are solely those of the author, not The Chicago Council, which takes no institutional positions.

  TUESDAY, DECEMBER 4, 2012

  THE GLOBAL ECONOMY
  FALL 2012 SERIES

  Event Audio (65.7MB, mp3) 

   
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