Will Obama's Plan Rebuild the Economy?

The Soviet government, which attempted to build a prosperous economy based on rational government planning and public property, without any concept of personal gain and profit, failed miserably. Despite its pervasive apparatus of repression, communism eventually collapsed under the weight of its economic inefficiencies.

But there is really no need to delve into such extremes as Soviet communism to find glaring examples of the public sector's inefficiency. In Japan, the government spent two solid decades pumping enormous sums into infrastructure projects. It built, repaired and rebuilt every road, bridge and public building twice over, with bureaucrats hard at work inventing new make-work projects. Yet, economic stagnation endured.

To keep its public works going, Japan increased its government debt from less than 50 percent of GDP in 1980 to over 170 percent currently. In 1999-2005, while the economy hardly grew at all, the fiscal deficit measured more than 7 percent of GDP.

But at least Japanese consumers own enormous household savings, which they hold in what they regard as very secure Japanese government bonds. As a result, the government has always been able to finance its deficit and to keep its bond yields extremely low. Not so in the United States. Our savings rate has been declining for years and in 2005-2007 measured less than 1 percent. The $2 trillion or so in new borrowing that the U.S. Treasury is projected to issue this year may yet overwhelm the Treasuries market.

No Alternative

There is no plausible alternative to the Obama plan currently, at least not on the political horizon. But this doesn't mean that it is going to work. Its most salient shortcoming is conceptual. The current crisis is the result of excessive borrowing and of living above our means. It seems unlikely that this kind of crisis can be lastingly overcome by even more borrowing and more spending.

Since the advent of the U.S. subprime mortgage crisis in 2007, which began to spread worldwide last year, a notion took root that it is an American phenomenon, that fat American consumers over-consumed and as a result virtuous global producers have had to suffer.

This is obviously too simplistic. On a fundamental level, the global crisis stems from a mismatch between supply and demand. Thanks to modern technology, the global economy has overcome the age-old challenge of producing enough goods and services for everyone. Now, any kind of production can be scaled up at will. Technology also increases productivity and reduces demand for labor, even as the world population continues to grow. It now stands at some 6.2 billion, and even the most optimistic projections see it peaking midway through the century at around 9 billion — 50 percent more people than today.

Moreover, the enormous populations of India, China, Russia, Eastern Europe and other parts of the world recently rejoined the global economic system after 50 to 80 years in a self-imposed exile. All these factors put systemic downward pressure on wages. In other words, our economic system has been remarkably efficient at producing a virtually unlimited number of goods and services, but it has not been very good at providing sufficient demand.

Over the past 20 years, the U.S. consumer has been willing to increase consumption and to fund it by borrowing mainly from foreign creditors, thanks to the dollar's status as a reserve currency. The result has been worldwide prosperity. Greater wealth spread around the world, but it was based on a number of asset price bubbles, all of which were underpinned by the biggest of them all, the U.S. debt bubble.

That bubble has now burst, triggering the deflation of all other bubbles. The free lunch has come to an end and, lo and behold, the bill has gone out to everyone who partook of it. Until a new sustainable system of funding global consumption can be developed, economic prosperity of the kind we have seen over the past two decades is unlikely to return.

—

Alexei Bayer runs KAFAN FX Information Services, an economic consulting firm in New York; reach him at [email protected]. His monthly "Global Economy" column in Research has received an excellence award from the New York State Society of Certified Public Accountants for the past five years, 2004-2008.