The 4 Issues Dragging Down the Economic Recovery

It seems bizarre even to mention this less than two weeks after the vote, but President Obama just won an election that was all about the economy. That’s what six in 10 voters on Nov. 6 told exit pollsters they were most concerned about. Not balancing the budget, reforming the social-safety net, or making the rich pay more in taxes—rather, improving an economy still laboring to find a growth groove more than three years after the Great Recession officially ended. “Our top priority has to be jobs and growth,” Obama said in a press statement on the Friday after the election, and he’s right.

Trouble is, it’s easy to get distracted. The bulk of Obama’s statement that day centered not on a new plan to boost growth right away, but on posturing toward a possible deficit-reduction deal with congressional Republicans. It’s a backward-but-necessary focus, due entirely to a nasty bit of economic timing for which the president and Congress set themselves up during Obama’s first term. A glut of reduced tax rates are scheduled to expire at year’s end, a crude-instrument set of spending cuts is ready to kick in, and the federal government will soon exceed its ability to borrow. If policymakers allow any of these three outcomes to happen, they would deal a contractionary blow to the recovery; all together, the trio would almost assuredly shock the economy back into recession. Resolving this so-called fiscal cliff to minimize the immediate drag on growth would remove one of the biggest anchors that economists identify as weighing down the recovery.

But if Obama wants his second term to be remembered for a new wave of hearty growth—and not as an extension of the anemic “new normal” that marred his first term—he’ll need to address several other forces that helped tug growth downward over the last several years.

Those forces are large and complex: a financial crisis in Europe, a slowdown in China, a bottoming-out domestic housing market, and high and volatile gasoline prices. All of those, to varying degrees, vexed the president in his first term. There is reason to believe that each one could dissipate over the next few years, serving as buoys for renewed growth; that federal policy decisions could influence heavily whether they do; and that smart reforms in how the government taxes, spends, and regulates could, in the absence of those anchors, finally help the economy expand at the pace necessary to put 12 million unemployed Americans back to work.

These are the crucial economic issues facing Obama as he enters his second term.

EUROPE AND CHINA

Fortunately for Obama’s reelection bid, the financial crisis that has crippled the eurozone did not spiral into a full-fledged economic meltdown during the summer or fall. Unfortunately, Europe’s outlook quietly darkened anyway. Recession has again gripped the Continent, and the International Monetary Fund forecasts an essentially flat year of growth there in 2013, with a 1 percent expansion in 2014. Budget-balancing maneuvers in Greece and Spain, both still in austerity free fall, have produced rising unemployment and increased public debt. Even Germany, the big engine of European growth in recent years, is showing signs of sputtering, University of Oregon economist Tim Duy noted this month.

Europe’s woes have hampered American exports (no-growth economies buy a lot less stuff than booming ones), and investors are worried that the financial contagion might spread to American banks.

The U.S. government can’t fix Europe’s problems. But it could do more to help fix them than it is. Today, American officials are mostly advising eurozone leaders on how to manage the crisis. Instead, Washington could start by leveraging a resolution of the Greek debt crisis, ensuring that the country won’t abandon the euro, which would trigger economic disaster in the region.

In a new research paper, Zsolt Darvas, an economist for the Brussels-based think tank Bruegel, contends that the best way to deal with Greek debt is for official lenders—governments, basically—to write it off or to stop charging interest on their loans for eight years. Doing so, Darvas writes, would bring Greece’s debt-to-gross domestic product ratio under 100 percent (from about 190 percent now) by 2020, alleviating the crisis.

U.S. officials could start by pushing the International Monetary Fund, of which America is a critical dues-payer, to lead the interest-free charge. “The IMF has a huge responsibility for taking part in the solution,” Darvas says in an interview. For European and American leaders hoping to avoid a worsening euro crisis, he adds, “the major risk in the short term is Greece. If they’re able to find a solution for Greece in the coming weeks and isolate the problem,” the risk would drop substantially.

Bolstering Europe would, in turn, help shore up the other big weak spot in the global economy: the slowdown in China. While Obama and Mitt Romney sparred in campaign debates over Chinese trade and currency manipulation, the far more consequential economic news from the Far East was that growth in China had decelerated faster than many analysts predicted. Further slowing in China would cut into U.S. exports, so the faster the Europeans can ramp up imports—from China and the United States—the better.

THE HOUSING MARKET

If Obama had lost reelection, it’s no exaggeration to say that his housing policy could have been the No. 1 reason.

Recent economic research is clear on one thing: The housing-market crash didn’t just help trigger the recession; it also waylaid the recovery. Plummeting home values pushed Americans to save more and spend less than they did in the years running up to the recession—sound practices over the long run, but poor prescriptions for a quick snap-back in the economy. Loss of home equity also robbed small-business owners, and prospective ones, of the ability to borrow against their houses to expand or start companies. Construction employment remains 2 million workers below its precrisis peak.

For three years, Obama’s housing efforts did little to reverse that tide. Only in the last year did he switch course, pressing—often in vain—for more-aggressive actions to write down home loans and spur more refinancing at rock-bottom interest rates. Meanwhile, the market sank like a rock, then, sometime in fall 2011, finally hit what appears to have been the bottom.

Now, economists at the real-estate website Zillow have seen four consecutive quarters of rising prices. If you look at just nondistressed properties and exclude foreclosed homes sold at a steep discount, you’ll see that housing values are down about 20 percent from theirpeak, which is up 4 percentage points from last year’s trough. The rebound should cool just a touch next year, but prices will continue to rise, Zillow predicts. “We’re seeing what we think is a durable recovery,” says Stan Humphries, Zillow’s chief economist. “What the second quarter of this year actually showed us is that the housing market has some strength of its own independent of the broader economy”—because even when growth stalled broadly, housing prices kept rising.

This is huge news for the economy overall, and it’s possible that lawmakers and federal agencies could make it even better. Edward DeMarco, the acting head of the Federal Housing Finance Agency, has thwarted much of Obama’s new, more aggressive housing agenda. If the president replaces him with a friendlier director, some economists say, the ensuing policies would boost the market and the economy overall fairly quickly.

Lawmakers could also slam the brakes on the housing resurgence if they push too hard, too fast, to reduce the government’s outsized role in the market. A tax-reform bill that limits or kills the mortgage-interest deduction would ripple into prices if it isn’t phased in. Likewise, Congress will need to strike a balance in transitioning the mortgage market away from its heavy reliance on public guarantees; at present, government-sponsored entities such as Fannie Mae back nine in 10 new mortgages. The government needs to reduce that level, but not so fast as to disrupt the recovery.

THE PUMP

High and volatile oil prices are not a glitch—they’re the future. China’s demand will continue to rise over time; global-supply increases, even with a U.S. boom in unconventional extraction, won’t keep pace. And neither the White House nor Congress can do much to stop that. Gasoline-price spikes tripped the recovery up a couple of times during Obama’s first term. Ironically, the next few years might not bring as much volatility, industry analysts predict, because the slowdowns in Europe and China have depressed demand a bit.

GOVERNMENT REFORM

Lawmakers aren’t just trying to cast away economic anchors in the next four years. They also have the opportunity to fuel growth. Expansionary fiscal policy would be ideal in the short term, but it seems unlikely to get through Congress anytime soon, so the next-best scenario probably lies in a series of bipartisan agreements to improve and streamline the role of the federal government.

You wouldn’t have known it from their debates and television ads, but Obama and Romney laid the groundwork for some meaningful, pro-growth, bipartisan compromises in the course of the campaign. Nearly all of the possibilities are rooted in changing the government—how it taxes, how it spends, and how it regulates—to improve economic efficiency.

For starters, both Romney and Obama promoted some version of corporate and individual tax reform. A wide swath of economists agree that the tax code has grown so complex as to be distortional, diverting investment from more productive sectors of the economy to less productive ones. Its myriad loopholes encourage businesses, instead of hiring workers or buying new software, to spend billions of dollars on what economists call “rent-seeking”—influence-peddling that seeks to bend the code (or federal regulation or spending) to favor some companies over others. “The body politic can’t agree on much,” says Matthew Mitchell, an economist at George Mason University who has written extensively on so-called crony capitalism. “But it seems like—at least, in principle—there ought to be bipartisan support for cutting spending that benefits the wealthy and well connected.”

Mitchell suggests creating a commission, modeled on the process that Congress has used to determine which military bases to realign or close, to weed out and eliminate federal spending that benefits certain businesses at the expense of others. Economist Michael Mandel of the Progressive Policy Institute suggests a similar body to reduce the government’s impact on business growth by identifying federal regulations to repeal or modify.

Even the deficit-reduction deal that Obama and Republicans are seeking could bear fruit for growth, economists at the Brookings Institution’s Metropolitan Policy Program say. (It’s not a natural connection, especially since borrowing costs are low now and there’s no evidence that debt is crowding out private investment.) In a research project, the Brookings economists contend that even when lawmakers slash spending, they can buoy growth by prioritizing spending on infrastructure, job training, and research and development. The authors of this project, too, would start with a BRAC-style commission to identify at least $200 billion in cuttable spending, half of which would reduce the deficit and half of which would go back into programs feeding job creation and growth.

Both casting off economic anchors and taking up growth-fueling reforms raise the likelihood that the American economy could finally hit a virtuous cycle of expansion in the next few years. Faster U.S. growth would help Europe escape recession by creating new demand for European exports. It would drive new household formation—young adults who finally get the jobs that allow them to move from their parents’ basement—and further lift housing prices.

Growth is the chief ingredient in balancing the federal budget. It is the chief defense against a European meltdown, a harder-than-expected landing in China, and a scenario in which prolonged long-term unemployment could permanently raise America’s natural unemployment rate. It should be, as the president says, the top priority.

_____________

KEY ADVISERS

Timothy Geithner: The last remaining member of the core economic team that guided Obama through the recessionary months of his first term, the Treasury secretary is widely expected to leave the administration.

Jacob Lew: Obama’s chief of staff is a top contender to succeed Geithner. In the meantime, he’ll lead negotiations with Republicans over how to resolve the fiscal cliff.

Alan Krueger: If he stays on as chairman of the Council of Economic Advisers, he could spearhead a legislative push dear to his academic heart (and Obama’s campaign rhetoric): reducing America’s income inequality.

Lael Brainard: Another possibility to take over Treasury, where she currently works as Geithner’s point woman on what has perhaps been the president’s thorniest combination of economics and diplomacy: the euro crisis.

WHAT’S MOVING

Housing initiatives: Edward DeMarco, acting head of the Federal Housing Finance Agency, stymied Obama’s late-term efforts to help underwater homeowners. Look for Obama to put someone more sympathetic in that post.

Fiscal policy: The economy could still use more aggregate-demand juice to get millions of unemployed Americans back to work. But so far Obama has not pushed hard for new infrastructure spending.

Europe and China: Their economic slowdowns have crimped U.S. export growth. Neither seems set to roar back to previous levels. Best-case scenario for the U.S.: Their economies don’t worsen.

This article appeared in print as "Anchors Aweigh."