Adam S. Posen: Putting Money on More of the Same from Economic Policy

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Just as in foreign policy, economic policy under the Bush Administration has been waiting for adult supervision. Just as the older wiser realists of the Scowcroft mode were registering complaints about the adventurism of the democracy promotion by invading those not nice to the President’s father approach to foreign policy, older wiser moderates, like Pete Peterson, have been pushing for greater fiscal restraint, multilateral approaches to international economic policy, and some regard for the domestic political impact of corporate excess. And just like on foreign policy, though less visibly, such pressures have been shunted aside by the Cheney-Rove team (in apparent contradiction of Cheney’s previous affiliations and purported conservative principles).
Last week’s nomination of Henry Paulson to be Treasury Secretary, supposedly due to the increased influence of Chief of Staff Josh Bolten, is supposed to be the sign of the adults finally taking charge of the nation’s finances. Along with Bush’s threat that he would exercise the first veto of his term on any excessive spending bill, some market chatter has been that this is the turning point, at least on the fiscal issue. The earlier meritocratic appointment of Ben Bernanke as Fed Chairman, as opposed to some Harriet Miers of central banking from the Bush bench of obscure buddies as had been rumored last fall, was also a hopeful sign about the Bush White House waking up to reality. Perhaps as on China, if not yet on Iraq, the Bush administration had learnt something from its recklessness, saw some looming risks (like a dollar crash or a surge in US indebtedness), and decided to behave like a reasonably sober if not yet responsible policymaker.
Would that it were so. It could turn out that way, and with the current team of Deputy Secretary Robert Kimmitt, and Undersecretaries Randy Quarles and Timothy Adams at Treasury, there are sure-handed public servants with bureaucratic and international experience who are capable of making Mr. Paulson effective in implementing policy shifts and managing financial crises. Unfortunately, there remain several reasons for skepticism about the policy goals themselves shifting meaningfully, none of which Mr. Paulson’s nomination, and Mr. Bolten’s supposed return (of himself and of the White House) to probity, are sufficient to alleviate:

  • Lots of momentum towards deepening difficulties — The US fiscal and international economic positions are not irretrievably or even critically bad, but the last five years of mismanagement have done quite a bit of harm. Despite a lucky rise in tax revenues this year, there are four major pressures for rising deficits in the near-term, even leaving aside the long-term demographic issues: military spending; Bush tax cuts not yet sunset; the Medicare Part D benefit (and desire to close its donut hole); and congressional desires to spare the middle class the Alternative Minimum Tax. Which of these is likely to recede whoever is Treasury Secretary?
  • Lack of credibility from within the tent — One might think of Paulson as a Colin Powell for economic policy, in which case the limited impact of such an appointment should be self-evident. The claim is made that someone of Paulson’s stature would never take the job unless s/he were guaranteed that s/he could speak truth to power and pursue mature policies; otherwise, s/he would resign and thus bring opprobrium on the administration. I know nothing about Paulson the individual or what went on in getting him to take the job, but as an economist I do know something about incentives and time-consistency. Once a senior official is in the administration, all forces motivate him/her to keep the job and convince him or herself that s/he can do more good working from within — meanwhile, the official can only resign once with no sure effect of so doing, so the threat is hardly scary to the White House. To the degree that Powell’s behavior in the first Bush term was driven by other than (solely) ethical cowardice, these structural incentives were at work; more tellingly, Paul O’Neill for all his documented economic misgivings and disputes did not willingly resign, and Josh Bolten oversaw the budget binges at OMB without a squawk or at least any noticeable restraining effect. There is no reason to think Paulson will be immune.
  • Absence of risks to what the Bush administration values — There are elected officials who do undertake painful fiscal measures for the sake of a country’s economic well-being. George Bush the Elder did so with regard to raising taxes, and Bill Clinton also did so by pursuing ‘Rubinomics’ rather than the spending programs that his 1992 platform seemed to portend. In both cases, the Presidents and their core advisers believed that the US’ best interest was served by an American economy integrated with the world, with sufficient government resources (or credit lines unused) to marshal military force as needed, and (moreso Clinton than Bush) the predominance of financial and technological efficiency over protection of older declining corporate interests. Fiscal rectitude and a strong dollar supported these values. On each of these counts George Bush the Younger, Cheney, and Rove have revealed the opposite priorities: international economic integration is to be subordinated to security relationships and frictions; military action is to be initiated lightly on the cheap without regard for the full costs of the undertaking; and the core corporate constituencies are those of reaction (mineral and oil extraction, land holders, steel and auto producers) and opposed to reallocation of capital. Paulson might try to bring a bondholder’s perspective into discussions, but do we really believe that the White House cares about the fortunes of New York-based financial corporations or Asian holders of US T-bills, neither of whom vote Republican?

There are many reasons to hope that the Paulson nomination to Treasury is indicative of a reversal of the Bush Administration of the destructive fiscal policies of the last five years, but far fewer reasons to expect that those hopes will come to fruition.
Adam Posen is Senior Fellow at the Institute for International Economics. The opinions expressed are solely his own, and not those of IIE. (c) A. Posen, 2006.

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