Obama's State of the Union Address

Like millions of others around the world, I settled down on Wednesday night last week to watch President Obama’s State of the Union address. And apart from being a little rambling, and way too long, with a rather quicker build up to the finale than we’re used to with Obama’s speeches, it was cogent, surprising in certain areas and yet conciliatory in others. A masterful speech I would say, but certainly it doesn't rank alongside his best to date.

From an economics perspective the surprises for me were: i) the lack of a proper analysis of why we need a new jobs package when the stimulus package hasn’t really started to show long-term results yet; ii) freezing of discretionary budgets along with a dropping of the “don’t ask don’t tell” military policy; iii) the emphasis on “full employment”; iv) the emphasis on export stimulus rather than protectionism; and v) the international comparisons that the President put into the speech relating to long-term growth. Let me elaborate…

First, the new jobs package. It is no mystery that some of the bigger long-term capital projects have been delayed – only late last week the high speed trains project was announced in various parts of the country – and clearly there are still others in the pipeline. So given that the economy is now growing, that the unemployment rate has stopped rising, that employment is at last showing signs that it might turn round soon ( - there was still a loss in jobs in December, 2009 – the latest figures), and that the financial system appears to have stabilized, it seems to me a little premature to do yet another stimulus. Surely some of the measures that the Obama administration wishes to pursue ( - including the $30bn fund for lending to small businesses) would do the trick rather than further increasing spending. This on top of the nervous situation about the rising deficit and mounting US debt. So from what I could gather from the speech the idea would be to set a date to quit increasing discretionary spending now, but in the meantime go for broke and increase spending now before the cap becomes law. The government spending multiplier needs some time to work – any student of macroeconomics would know that the fiscal lags inherent in any new spending take time to work their way through the economic system. [See http://www.cbo.gov/ftpdocs/99xx/doc9968/hr1.pdf - where this is a Jan 2009 estimate and many of the projects have taken longer than anticipated to come online.]

Second ( - and this is one reason I’m glad I didn’t post this blog immediately after the speech), military spending and “don’t ask, don’t tell”. I think it was a brilliant move on the part of the Obama administration to exempt the military from the discretionary spending freeze from next year, and announce the scrapping of “don’t ask, don’t tell” at the same time. The bad cops in the form of Pelosi and other democrats were immediately out there doing their jobs to make sure that the military understands that there are voices now on the left (see my previous post on this) favoring some trimming of military budgets. You can just imagine the conversation with the military top brass telling them that if they don’t want to scrap “don’t ask, don’t tell”, then it would be difficult to fend off the democratic calls for a military spending freeze ( - and this isn’t just a one year freeze…it goes on for 3 years). If I was top brass in the military I know what I would do!!

Third, as an economist, I was surprised to hear the term “full employment” once again being introduced into the political discourse. Most economists would use the term “natural rate of employment” given that this has become the level of employment that we use in our own academic work and one that makes a lot more sense than “full employment”. [For those of you not in the know on this see http://en.wikipedia.org/wiki/Natural_rate_of_unemployment] Psychologically what it means to me is a return to the “Keynesian” stimulus economics of the 1950s, when we were not worried about the effect of inflation and we were more worried about adjusting spending to an “optimal” level. We are not currently in this situation now, as we know that inflation can occur from these actions, particularly if interest rates rise which will automatically increase the burden of the debt on government finances. Potentially this is a vicious cycle – the more debt we incur, the more likely a sudden collapse in foreign confidence ( - look at what happened in Dubai if you don’t believe me on this), and the more likely interest rates will have to rise, making recovery less likely. It is clearly important to get this balance right ( - the balance between stimulating the economy and causing alarm among our foreign lenders), and in my opinion using terms like “full employment” implies that large budget deficits will continue into the future.

Fourth, the new and welcome emphasis on export spending. This was a high point in the speech that a lot of people missed. Why? Politically, because it placed new emphasis on developing new markets and boosting exports rather than resorting to protectionism. But what about the economics? First, it recognized that the U.S., because it started the current global economic downturn, can "hitch a ride" from other countries that get out of the recession faster, as other economies suffered a "shock" transmitted from the U.S. whereas the U.S. clearly had some major systemic problems that it needs to address.  Second, it implies that the exchange rate needs to stay low if the "doubling of exports in 5 years" and the "2 million more jobs" are to happen.  If for some reason the administration has it completely right (or some other country suffers a big shock which causes investors to seek the "safe haven" that the U.S. dollar traditionally affords) and so the dollar begins to rise again, this would derail their export objective. So the Obama administration must be betting on a low or even lower dollar than we have right now to make this happen. All food for thought.

Last, the international comparisons on long-term economic growth that the President mentioned in his speech. He specifically mentioned China and Germany and the stimulus measures that they have adopted that also enhance long-term growth prospects. It was refreshing to hear this use of “best practice” to justify new economic policy in the US. This was a hallmark of the UK Blair administration, who looked at what had been tried elsewhere to get the best ideas about policymaking, and it has clearly taken root in the current administration’s economic thinking. On a side note, although Fed Chairman Bernanke’s expertise is on the Great Depression, I would argue that we also need to understand what went wrong in Japan in the 1990s and 2000s to get it right in the U.S., as our situation much more closely mirrors what happened there. More on this next time…