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“The Good, the Bad and the Ugly” Some of the Economic Challenges Our Next President will Face

“The Good, the Bad and the Ugly” Some of the Economic Challenges Our Next President will Face. Outline. To be discussed in reverse order: “The Ugly” - the current financial crisis “The Bad” – inequality, health care, social security “The Good” – productivity growth.

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“The Good, the Bad and the Ugly” Some of the Economic Challenges Our Next President will Face

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  1. “The Good, the Bad and the Ugly”Some of the Economic ChallengesOur Next President will Face

  2. Outline To be discussed in reverse order: • “The Ugly” - the current financial crisis • “The Bad” – inequality, health care, social security • “The Good” – productivity growth

  3. “The Ugly”orWhat Just Happened?

  4. Events Leading up to the Financial Crisis

  5. Events Leading up to the Financial Crisis

  6. Timeline of the Last 14 Months

  7. From the NY Times September 11, 2003: The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago. Under the plan, a new agency would be created within the Treasury Department to assume supervision of Fannie Mae and Freddie Mac… Fannie Mae and Freddie Mac have been criticized by rivals for exerting too much influence over their regulators. Among the groups denouncing the proposal today were the National Association of Home Builders and Congressional Democrats who fear that tighter regulation of the companies could sharply reduce their commitment to financing low-income and affordable housing. ''These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis,'' said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ''The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.'' Didn’t Any Officials Foresee the Crisis?

  8. The Lesson for the Next President:Good intentions are not enough The best of intentions (extending home ownership to low income individuals) has led to the worst of crises. Everyone, especially low income individuals, will be much worse off as a result.

  9. The Fallout

  10. The Bubble Bursts

  11. The Effects Spread • 1 in 6 homeowners owes more on mortgage than the house is worth • Foreclosures have climbed dramatically, jumping 71 % in the 3rd quarter of 2008 relative to year earlier • Worldwide credit markets have seized up – no one trusts anyone else’s balance sheet • The stock market has plunged

  12. Credit Markets Seize Up

  13. The Stock Market Crashes Source: Shiller, updated to Oct. 24, 2008

  14. S&P 500 Stock Price Index Adjusted for inflation, in percentage terms 400 300 200 100 0 1880 1900 1920 1940 1960 1980 2000 year - 39% - 27%, 4 yrs to recover peak - 81%, 29 yrs to recover peak - 53%, 16 yrs to recover peak - 67%, 20 yrs to recover peak - 46%, has not recovered peak - 34%, 2 yrs to recover peak Source: My calculations based on Shiller’s data.

  15. Employment has been declining since Jan. 2008 Employment is expected to plummet in the October report.

  16. What can the government do? • The attempts by the Treasury and the Fed to provide liquidity to financial markets and recapitalize banks are the best hope. • The potential effects of more fiscal stimulusare uncertain. Consider the effects of the recent tax rebate:

  17. 11000 10000 9000 2006 2007 2008 month 5 4 3 savrt 2 1 0 2006 2007 2008 month The Effects of the Recent Tax Rebates Tax rebate After-tax income Consumer expenditures Saving rate

  18. Bottom Line on Current Crisis • We will probably have a moderate to severe recession because of the fallout from the subprime mortgage debacle. • If government feels compelled to try a stimulus package, infrastructure investment would be best. At least spending on infrastructure would have some side benefits, even if it didn’t stimulate the economy.

  19. Some Long-term Economic Challenges • Income Inequality • Health Care • Social Security and Medicare • Global Warming (I won’t have time to discuss)

  20. Income Inequality There has been a dramatic increase in income inequality in the U.S. since the late 1970s. Economists attribute the increase to factors such as technological change and globalization.

  21. Real Wage Growth by Education Level - Males From Autor, Katz, & Kearney (2005). Composition-adjusted full-time weekly earnings.

  22. Real Wage Growth by Education Level - Females From Autor, Katz, & Kearney (2005). Composition-adjusted full-time weekly earnings.

  23. Caveats (1) Recent research suggests that the real wage growth of low income households has been faster than we think. The price of goods bought by low-income people have increased much less than the general rate of inflation. Adjusting for this effect eliminates 2/3 of the increase in inequality. (2) Time use studies show that those with higher education levels now work longer hours and have less leisure than those with less education. On average a high school dropout has 9 hours more leisure per week than someone with a graduate or professional degree.

  24. Historical Perspective: Income Share of the Top 10% of the Income Distribution, 1917 - 2006

  25. Comparison of France and US

  26. How Did France Prevent the Rise in Income Inequality? • High minimum wages • Highly regulated labor markets • Generous unemployment benefits • Powerful unions But at what cost?

  27. Unemployment Rate Trends in France vs. the U.S.

  28. Bottom Line on Wage Inequality • Wage inequality has risen significantly since the 1970s • However, the well-being of lower wage individuals may be understated. • Trying to decrease wage inequality through labor market restrictions might lead to higher unemployment. • Obama’s tax reforms do more to reduce inequality than McCain’s reforms.

  29. Health Care • The U.S spends more than 15% of GDP on health care • For the privately insured: in 1960, 62% of expenses were paid out-of-pocket; in 2006, only 22% were paid out-of-pocket • 16% of the population is without health insurance • 27% of the population is covered by government health insurance

  30. Health Expenditures as a Share of GDP, 2006 Belgium Canada Denmark France Germany Italy Japan Netherlands Norway OECD Portugal Spain Sweden Switzerland United Kingdom United States 0 5 10 15 Public Private Source: OECD

  31. Source: OECD

  32. Would we be better off with a national health insurance system? Some Comparisons of U.S. and Canada Current spending per person on health care: U.S. $5,700 Canada $3,000.

  33. Bottom line on Health Care • All evidence points to gross inefficiencies in the U.S. health care system. • Other countries have flaws in their systems, but they seem to be able to produce similar health outcomes at much lower cost. • Reforming health care is one of the most difficult challenges facing our next president. • Neither candidate has suggested the overhaul we really need.

  34. Social Security and Medicare The basic problems: • Too many retirees per worker (due to longer life expectancies and reduced fertility) - In 1960, 9 workers paid the bill for each retiree’s Social Security Benefits - By 2030, there will be only 2 workers available to pay the benefits for each Social Security recipient • Medicare costs are rising dramatically

  35. Social Security and Medicare have dramatically cut the poverty rates of the elderly.

  36. A SUMMARY OF THE 2008 ANNUAL REPORTS Social Security and Medicare Boards of Trustees A MESSAGE TO THE PUBLIC: “The financial condition of the Social Security and Medicare programs remains problematic. Projected long run program costs are not sustainable under current financing arrangements.”

  37. Projected Tax Income Shortfall, Percentage of GDP Source: Social Security and Medicare Board of Trustees

  38. Bottom Line on Social Security and Medicare Either taxes must be raised or benefits must be cut. The problem with raising taxes is that it could discourage work. One way to cut benefits is to raise the retirement age. McCain has indicated that entitlements must be cut, Obama hasn’t indicated that he will try to address this problem.

  39. The “Good” The U.S. is still a leader in productivity, which is the ultimate source of increases in standards of living.

  40. Recent US Productivity Growth has Outperformed Other G-7 Countries

  41. Relative Labor Productivity, G-7 in 2007

  42. Conclusion – the next president faces many economic challenges The Good – The US continues to lead in productivity. The Bad – Income inequality, the health care system, and the future of Social Security and Medicare are major challenges The Ugly – the current financial crisis

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