Robert E. Rubin, Knight-Bahehot Anniversary Dinner
November 8, 2004
New York, NY
I've been asked to discuss the outlook for the global economy. That is obviously a vast subject. So, what I will do is focus on three principal points:
- The division of economic prowess and geopolitical power amongst the major regions of the globe, in my view, is likely to undergo a change of historic proportions over the decades ahead, with profound ramifications that American policymakers, business people and investors are only in the early stages of recognizing and addressing.
- In this context, the United States economy is at a critical juncture, with great opportunities but also great challenges.
- The outcome at this critical juncture will be enormously affected by the decisions our political system makes, and that in turn will be greatly affected by the media.
Put all this together, and I believe the uncertainty and the complexity of the outlook now is probably the greatest in many, many years that I've been involved in markets and economic issues. And, that complexity poses immense challenges for policymakers, the media, investors and business people in charting a course forward. Moreover, and along these lines, the factors that in my judgment will most importantly affect our country's future are not the most focused on - for example, the actions of the Fed - but rather more fundamental matters that are generally either underweighted or ignored in forecasting, probably because they are too complicated, can't be quantified, don't fit readily into models and are not susceptible to judgments about timing; but, that does not make them any less real or powerful. And I'll get to them in a few moments.
First, let me turn very briefly to what I believe is likely to be an historic rearrangement of the economic and geopolitical positions of the major regions of the world.
China, India and non-Japan Asia are generally viewed - and I think rightly - as likely to be the most robust and dynamic part of the global economy for years and decades ahead. I would take that one step further, and say that China is likely to become the largest economy in the world and a tough minded geopolitical power equal to any other country at some point in the next few decades. China clearly faces many great challenges, but, having spent considerable time with Chinese political and business leaders while I was in Washington and since, I, at least, am convinced that their understanding, commitment and vision and the culture of the Chinese people creates a high probability that China will meet its challenges.
Europe, on the other hand, seems likely to have slow growth and relative decline, unless the political systems address structural reform in ways that they seem to me to give little evidence of doing, despite the valiant efforts of some leaders, a good deal of rhetoric and some real accomplishments. One caveat is that the new entrants to the European Union may provide competitive pressure that catalyzes change.
Japan has made some change and has had some cyclical success, but still has not done most of what needs to be done on structural reform, trade openness, banking, fiscal and other matters to realize its potential. I think that Japan's history suggests that it will at some point rise to these challenges, but even then, growth is likely to be slow, due to Japan's daunting demographics.
And that brings us to the critical juncture in the United States.
On the one hand, the United States has great comparative advantages: our historical embrace of change, our cultural willingness to take risk, flexible labor markets, and the size of our economy and economic infrastructure. Moreover, this is a time of powerful change - globalization and technological development - that offer great opportunities, especially to economies such as ours that embrace change.
On the other hand, we also face enormously complex and hugely consequential challenges and risks. We must meet those challenges to realize our opportunities, and failing to meet those challenges, could lead to serious and sustained difficulty. And, in my judgment, to meet these challenges, we need to change direction on many fronts, which will be complicated and difficult both substantively and politically. As to substantive policy, though, I believe there is a high probability - not a certainty but a high probability - that effective responses could be found. With the elections of last Tuesday, the probability is presumably that we will stay our current course, but the outcome of the election does not change economic reality and therefore does not change the overriding importance of these issues or of putting in place sound policy responses to them. Those realities are very likely, in my judgment, to creep up on policymakers, or perhaps even attack much more powerfully, and create increasingly strong pressure towards change, or possibly at some point difficulties so great as to force change. There is also the possibility that the Administration itself will decide to change direction in the face of these realities before difficulty develops - which would obviously be far the better path. In addition to substantive policy views, the choices that the Administration and Congress make are likely - as is always the case - to be influenced by the politics around these issues, which can either be a constraint on, or an impetus towards, sound policy. And as to the politics, I think the prospects are troubling. I'll return to that in a few minutes, but basically let me very briefly list these challenges, with comments on just a few of them.
To start, over the past 3 ½ years, the fiscal position of the United States government has gone from the Congressional Budget Offices' projection of $5.6 trillion surplus, made in January 2001, to the projection now made by Goldman Sachs, and most independent analysts, of a 10-year deficit of $5-5 ½ trillion. Adjusting for methodological differences, the 10- year fiscal position of the United States government has deteriorated by roughly $9 trillion. The Congressional Budget Office also estimates that the 2001 and 2003 tax cuts will cost roughly $4 trillion over the next 10 years, if made permanent, which puts them at the heart of this long-term fiscal problem. I believe that tax cuts were an appropriate policy response to economic difficulty in 2001 - and said so in an op ed in the New York Times at the time - but temporary tax cuts aimed toward lower and middle income people who live week to week and are likely to spend most of any tax windfall could have provided all the stimulus that we wanted at far less cost per dollar of stimulus and we would have avoided the great preponderance of the long-term fiscal morass we now face.
Ten-year numbers are highly unreliable, but the risk is as great on the upside as the downside - in fact, Goldman Sachs believes the risk is greater on the upside - and depending on greater than expected growth to solve the problem when these deficits have the very serious potential of undermining growth seems particularly imprudent as public policy. Moreover, after the 10-year federal budget window, the projected fiscal situation becomes far more difficult with each passing year, as the baby boomer retirements begin to increase rapidly, with the principal problem being Medicare.
Virtually all mainstream economists agree that sustained long-term deficits will crowd out private investment, increase interest rates, reduce productivity and reduce growth, and the Federal Reserve Board and others have models that predict these effects would be serious with deficits of the magnitude projected. However, even more dangerously, if markets begin to fear long-term fiscal disarray, and if foreign providers of the capital inflows we are now so dependent on share this fear and also become concerned about our currency, then the markets may begin to demand sharply higher interest rates for long-term debt, with all the problems that may lead to for markets and our economy. Interest rates have not been materially affected so far, because of the paucity of private sector demand for capital, but a change in that demand - or simply a change in market psychology - as for example, because of problems regarding the dollar - could lead to a focus on long-term fiscal conditions, and then the risks could become realities. Also, the evidence of the early 1990s strongly suggests that prolonged deficits can have serious adverse effects on business and consumer confidence more generally.
(In my view, for all of these reasons, a dramatic change in fiscal policy is imperative, and I think that reality is likely to increasingly assert itself on the political system however unwilling or reluctant that system may be to deal with the actual hard choices that restoring fiscal discipline poses. Movement towards sound policy, unfortunately, is made all the more difficult by the very limited public understanding of the ramifications and trade-offs involved in fiscal matters.) (In 1998, when our projections began to show substantial surpluses in the federal budget for the first time in roughly 30 years, even President Clinton, with all of his immense political and communications skills, couldn't figure out a way to make the economic importance of fiscal discipline and paying down the federal debt resonant politically with the American people, to offset the anticipated pressure to use that surplus for tax cuts, until we happened upon the idea of linking paying down the debt to what we called "saving Social Security". Our point on Social Security was valid, but had nothing to do with the fundamental economic argument, which we could not figure out a way to make in a way that would work politically.)
As to our large current account deficits, let me just add that our great dependence on capital inflows from foreign central banks, who in a sense are subsidizing us for their own trade purposes, subjects us to the risk that because of the concerns I just mentioned or their own internal problems, they begin to make a different calculation that then leads to a sharp deterioration of our currency and a sharp increase in our interest rates.
The best way to minimize this risk of a sharp and sudden currency decline is with sound fiscal policy that both reduces the trade deficit that derives from inadequate national savings and engenders confidence.
Let me now just briefly list a number of other challenges and risks: very high levels of consumer debt, that at the very least make our economy more vulnerable to significant interest rate increases; a broad array of extremely complex geopolitical issues, which are massively important in any event but can have greatly varying impact on our national security and our economy depending on how well or how badly they are handled - and there are obviously many questions and debates about the best way forward; and great antagonism towards the United States around the world, as all of you who are involved internationally know, that can prevent us from being able to marshal support from other countries around our economic and national security objectives and can hurt American business abroad. We must exercise leadership for the global community to act, but in doing so move to an attitude of mutual respect and true partnership.
On the domestic front, we must reform the health care system in the face of rapid increases in health care costs that are a serious competitive issue and declining coverage, and as many of you know from your own experience, and as I learned in the course of our efforts at health care reform in 1993 and 1994, this is an extremely complex problem with great disagreements amongst health care analysts, and no obvious answers. Also, as to domestic policy, the probability of longer-term supply-side and geopolitically driven oil price pressure is high enough to call for an energy policy focused on conservation and alternative sources of energy.
And finally, we face an historic competitive challenge from large numbers of well-educated workers in low-wage environments, especially China and India, connected to the United States by real-time technology that eradicates distance as a factor in locating many activities, from call centers to high value added software development and legal research. The best policy path forward in my judgment is the agenda that President Clinton presented in the East Room of the White House, with all the living Presidents, except President Reagan who was not well, standing behind him, when he advocated NAFTA in 1994: that is, trade liberalization inextricably intertwined with help for those who are dislocated by trade, and a powerful program to promote American competitiveness, including greatly improved public education, greatly increased investment in basic research and certain kinds of infrastructure, and much else. Also, fiscal discipline is critical to spur high levels of private investment and to provide the resources to fund these requisites for success. However, the politics of all of this is even more difficult than the always-difficult politics around trade, because so many Americans see their economic difficulties and anxieties through the prism of trade. As President Clinton also said, those who advocate trade liberalization too often do not support the necessary domestic policies, and those who support the domestic policies often oppose trade liberalization, and the right path is to bring both perspectives together. The politics of all of this, however, will require greatly increased public understanding of what is an immensely complicated matter. The dollar is obviously an important issue in this context; I will limit my comment at this point by saying it presents a very complex challenge for policymakers and also for investors and business people.
I could go on, but I think that I've captured the preponderance of the essential challenges. For investors, the range of realistically possible outcomes is extraordinarily broad - from solid growth and favorable markets over the years ahead to difficulties of extended duration. And, outcomes will be enormously affected by the policy decisions our political system makes. All of this creates a very difficult environment for investors, and a greater than usual need to be informed thoroughly on, and make judgments about, a wide array of issues.
With that, let me now focus for a few more moments on our political system and the central role of the media in whether or not that system produces sound policy decisions.
Let me start with two examples, which I think make all of the points I want to make. In 1995, President Clinton proposed a $20 billion program to help Mexico deal with a financial crisis that had the potential for enormous adverse impact on the United States, and secured bi-partisan support from the leaders of both Houses. Then, as the crisis continued to worsen, and the need for action became critical, the whole matter bogged down in Congress. Finally, one of the leaders in the House told me that while most of its members recognized the importance of this proposal, they didn't want to vote for it because it was highly unpopular and would be relieved if we could find some way to proceed with executive action. Fortunately, we were able to do that, but with some irony we were then strongly attacked in Congress for acting without their approval. Similarly, a key House member once told me that he agreed with us on a request we were making for a well constructed foreign aid measure, but would not support us because supporting us would be widely criticized by his constituents and opposing us would never be criticized by anyone. And, on fiscal matters as we learned in 1993 when our deficit reduction program barely squeaked through the House and Senate, many elected officials will support the objective of fiscal responsibility but refuse to support the difficult specifics that are required to meet that objective. My own 6 ½ years in Washington left me with the view that our democratic political system would produce far better results if elected officials feel they will be held accountable to an informed electorate for making sound decisions that are politically difficult, instead of feeling - as they too often do now, and as was suggested in my examples - that they will be punished for making decisions that are sound but difficult. And that brings us back to the enormous importance of greatly increasing public understanding of the issues critical to our future, including fiscal probity and international economics and interdependence, both woefully little understood at present.
And, there, the media is central, because most people know virtually everything they know about public issues through the media. I knew many journalists while I was in Washington, also before and since, who were deeply knowledgable and thoughtful and treated their critical roles with the utmost seriousness of purpose - even if what they wrote sometimes drove me up the wall. On the other hand, the media as a whole - as a friend of mine who is the Chief Executive Officer of a major media company said to me recently - is a business that must appeal to viewers, readers, and thereby to advertisers. The result, it seems to me, is a tendency to treat issues with more flair but less balance and analysis - and to allocate coverage more toward what will most appeal to people - than is optimal for developing public understanding of critical issues. I know that all of you wrestle with these questions all the time, but I believe never has it been more important for our country, given the issues we face and current policy direction, to find better answers than we have today.
Let me conclude by saying that the American political system and American society have historically been enormously resilient and they've risen to meet many great challenges. If past is prologue, that would suggest a high probability this will happen again. On the other hand, we have a lot of work to do. And, in the vital effort to have our democracy work effectively to produce sound policies at this critical juncture, and to give investors and business people the information to navigate most effectively in this complicated environment, Knight-Bagehot's mission of promoting high standards of business journalism and educating journalists is of the utmost importance. So, I am delighted and honored to be here this evening, to help celebrate an organization with a distinguished history of fulfilling a mission that has never been more vital. Thank you.