Economics is Always the First Casualty of Politics

Both the past wild week of debt negotiations in Congress as well as the debt downgrade of the US by Standard & Poor represents once again the Barbier dictum: Economics is always the first casualty of politics.

In my opinion, the Obama Administration made a fundamental mistake earlier this year in not endorsing the Bowles-Simpson plan on deficit reduction that called for a combination of revenue increases, spending cuts and entitlement and tax reforms as the basis of a plan for deficit reduction over the medium term, while at the same time arguing that there is the need for continued government spending on selected infrastructure and investment opportunities in the short term while continuing to be in recession. From the beginning of the 2008-9 recession, such short-term government spending needed to be supported by a number of economic incentives and policies to stimulate private sector investment, too. However, as long as the US economy remains in a recession with lack of consumer or private investment spending, public sector spending in the short term is necessary. But by adopting the Bowles-Simpson plan immediately, the Obama Administration would have signaled to the markets and the rating agencies that tackling US deficits and debt in the medium and long term, once economic recovery had started in earnest, would be the main priority.

Instead, the last week or two has demonstrated that sound economic policy has been hijacked by an ideological political debate that has focused purely on cutting spending and not managing either the recession or medium-term budget deficits. Clearly, the Republican Party has been irresponsible in promoting this ideological political stance, and as a consequence, has brought the US economy to the brink. Although one can agree with US Treasury Secretary Geithner that Standard & Poor is making its decision to downgrade US debt based on political considerations, the wakeup call to US policymakers should not be ignored: stop playing politics with the US and world economy. This is a message that the Republican leadership in Congress must especially heed.

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Meanwhile, economic policy needs to focus more securely on the short-term problems of jobs, economic growth and investment. In his speech on August 8, President Obama suggested that extending unemployment insurance and the reduction in payroll taxes as the means to this end. Unfortunately, this is not enough, especially for instigating a sustainable global economic recovery, much less one in the US.

At the beginning of the 2008-9 recession, at the request of the UN Environment Programme, I put together a global strategy for instigating a worldwide “green” recovery, called a Global Green New Deal (See A Global Green New Deal: Rethinking the Economic Recovery). I argued that, although the over $500 billion devoted by the Group of 20 (G20) largest and richest countries to clean energy and other green expenditures or tax breaks was a good start, it was not sufficient to launch a sustained green recovery. Instead, implementing further green measures will require G20 economies to commit to increased public investments, new pricing policies, improving regulations, more aid disbursements and other policy changes. But the positive multiplier effects of any additional short-term green stimulus and policies in support of an economic recovery will be counter-productive if they lead to unstably large fiscal and trade deficits, long-run real interest rate rises and inflation. There is also concern that green stimulus programs that emphasize short-term employment and environmental effects may be less effective in creating jobs and growth in the longer term.

A new policy strategy to enhance a global green recovery is therefore needed urgently. The new strategy requires two essential elements.

First, there needs to be a coordinated global response led by the G20 to support the main objectives of the Global Green New Deal. It recommends an expenditure of 1% of global GDP over a period of years on green initiatives. G20 countries should prioritize energy efficiency and clean energy investments, and developing countries should aim to improve agricultural productivity, freshwater management and sanitation. Such investments should be accompanied by a swath of domestic and international policies – from removing perverse agricultural, fishing and energy subsidies to taxing or trading carbon emissions, instigating tax credits for low-pollution cars and other clean-energy innovations, financing the transfer of green technologies to developing countries and creating a global carbon market through climate change negotiations.

Second, the G20 also needs to target and coordinate assistance to developing economies in science, technology and innovation (STI) for clean energy and energy efficiency. Such assistance is necessary to overcome the technical and market behavior that low and middle income countries face as obstacles to clean energy investment. Most developing economies lack even the minimum research and development (R&D) capacity and skilled workforce capable of attracting the transfer of many energy efficiency and low-carbon innovations. Reform and expansion of the Clean Development Mechanism (CDM) would be one important means of facilitating STI in clean energy for low and middle income countries.

At a time when political systems in the US and worldwide are increasingly dysfunctional, it is even more important to demonstrate a clear vision of how to steer the world economy out of this mess, rather than allow politics to continue to dominate sound economic thinking.

This blog expands on an earlier posting for the August 8 Daily Beast Business blog.