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What’s missing from the cliff debate: Growth

By Fareed Zakaria,January 03, 2013

The deal to avoid the “fiscal cliff” is a small victory for sanity, but what it says about the future is bleak. Washington will lurch from crisis to crisis, kicking problems forward and placing Band-Aids on those that it does address. There are likely to be no large-scale policy initiatives — on tax reform, entitlements, energy policy or even immigration. This is worrying, because beyond the self-inflicted crises of the cliff and the debt ceiling, the United States faces a much deeper challenge.

For more than a decade — and longer, by some measures — U.S. growth rates have slowed, recoveries have been jobless and median wages have declined. Some combination of the information revolution and globalization has placed tough pressures on high-wage countries such as the United States. These new forces are accelerating, and without a strategy to revive growth, all of our problems get worse, especially long-term debt. Washington’s focus has been on taxing and cutting — but it should be on reforming and investing (a theme I expand on in an essay in the current issue of Foreign Affairs).

Historically, when the U.S. government, World Bank or International Monetary Fund have advised troubled countries, they have stressed that achieving fiscal stability is only part of the solution. The key to reviving growth is structural reforms to make an economy more competitive, as well as investments in human and physical capital to ensure the next generation for growth. Yet we have been unable to follow our own prescriptions.

The United States could become more competitive in many areas. Our gargantuan and corrupt tax code clocks in at 73,000 pages, including regulations. Vast aspects of the economy, such as agriculture, receive massive and distorting subsidizes for no larger national purpose. Regulations in industries such as finance are highly complex, and sometimes worse, with banks being supervised by multiple federal agencies and 50 sets of state agencies, all with overlapping authority.

If the case for reform is clear, the case for investment is vital. The big shift in the U.S. economy over the past 30 years has been a decline in the quality of physical and human capital. To understand the cost imposed by our infrastructure deficit, consider just one example: the federal aviation system. It is antiquated and desperately needs an overhaul. Upgrading its computers to the next-generation system that would allow for much faster and safer air traffic would cost an estimated $25 billion. By not making this investment, we are measurably slowing economic growth. Similar examples abound, and deferred maintenance usually costs more, because eventually the system starts breaking down and has to be fixed.

Or consider our human capital. We used to lead the world in young adults with college degrees; the United States now ranks 14th and is dropping. U.S. retraining programs are not as good nor nearly as extensive as those in, say, Germany, where workers retain skills and can command high wages even when competing against their South Korean counterparts. Some of this is culture and history, but much of it boils down to money.

The federal government spends plenty of money, but the largest share of the budget now goes to entitlements. Spending on present consumption, such as entitlements, has large constituencies, but spending for the next generation of growth has few supporters. There is little prospect that Congress will shift this balance in the near future. What’s more likely is that investments will continue to be whittled down as entitlement spending grows as a consequence of demography and ever-rising health-care costs.

The pox for these problems does not fall equally on both political parties. Over the past two years, the Obama administration has made proposals to stabilize long-term debt and yet make investments for the future. The administration did not go far enough on entitlement reforms, and the Democratic Party as a whole is too obstinately opposed to reform in this area. But the Republican Party seems to be energized by people who would rather maintain ideological purity than make practical progress. It’s a pity, because Republican concerns about the long-term debt and entitlements are valid and need to be addressed.

Recently, scholar Ezra Vogel, who predicted that Japan would become the world’s No. 1 economy, explained that although Japan’s economic miracle was real, he never foresaw how its political system would seize up and become unable to solve the challenges it faced in the 1990s. Today, Japan remains a rich country but one with a diminishing future. Its per capita gross domestic product is 24th in the world and falling; its gross government debt-to-GDP ratio stands at 230 percent.

What we don’t want is to continue toward a scenario in which, 20 years from now, we look back and say that the U.S. economy was basically vibrant but its political system seized up, dooming the country to a Japanese fate.

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