Corporate Governance

The European Commission, the EU’s antitrust authority, announced a decision earlier this week to fine Microsoft $731 million for violating the terms of a previous antitrust settlement, which analysts say may constitute a warning to other dominant multinational firms and signals the EU’s willingness to go farther than their U.S. counterparts. U.S. antitrust law aims to increase the economic efficiency of markets by preventing firms from unduly limiting competition. In this CFR Backgrounder, Renewing America contributor Steven Markovich examines the evolution of U.S. antitrust policy and its role in the global marketplace.

While freer trade makes everyone collectively richer, the impacts are unequal. There are winners and losers, and even among the winners there are some who gain a great deal and some who gain very little. The precise relationship between expanded globalization and rising income inequality remains in dispute, but economists now generally accept that freer trade, immigration and investment, along with technology, have played some significant role in the growing gap between the rich and poor and the shrinking middle class in the United States. For many years, I have listened to economists offer the same remedy: the collective benefits of trade are so large – Americans as a whole are are some $1 trillion better off as a consequence of decades of growing globalization, according to the most widely cited study – that the winners should compensate the losers. Those whose incomes are rising – the bankers, the consultants, the business executives, and others whose market value has been enhanced by globalization – should be taxed to help out the factory or construction workers who are losing out to lower-wage competition. Such help could take many forms, from unemployment insurance to job retraining programs to wage subsidies that help close the gap between better-paid manufacturing jobs and the lower-paid service jobs that laid-off workers are most likely to find. But at a fascinating conference yesterday at the Peterson Institute for International Economics entitled “Ethics and Globalization,” Bill Galston of Brookings posed a question: What happens if the winners from globalization refuse to compensate the losers, or compensate them inadequately? This, he pointed out, is precisely what has happened over the last generation in the United States as lower-skilled workers have lost jobs or seen their wages fall in part as a result of global competition. And, Galston continued, if we know that the winners have no intention of compensating the losers, then don’t we have an obligation to think about “second best” policies that might help spread the gains from globalization? The challenge produced startlingly little in the way of sensible responses from the assembled experts. Ann Krueger, the former deputy managing editor of the International Monetary Fund, raised the usual alarm bells, warning that any effort to restrict imports or otherwise protect American jobs would send the country careening back to the horse-and-buggy era. Galston wasn’t suggesting protectionism, but the default response of too many economists is still to raise that specter, even though there has been surprisingly little new protectionism in the wake of the financial crisis. Arvind Subramanian of Peterson had a more interesting response. He pointed out that the rapid economic growth triggered in China, India, and other emerging markets as a result in part of globalization has unquestionably reduced global inequality, even as it has increased inequality within the United States and other advanced economies. And he was quite candid in noting that, as an “international cosmopolitan,” he is not terribly concerned if, for example, Chinese exchange rate policies displace American workers. What worries him is that workers in countries poorer than China will be hurt. Not much comfort here for the losers in the United States. Subramanian did suggest that globalization has created the need for bigger social safety nets, but then noted that those reaping most of the benefits – corporations and highly skilled individuals – are increasingly adept at avoiding the taxes that might pay for these programs. The only slightly encouraging signal came on a separate panel from Michael Froman, the top White House adviser for international economic affairs who is considered a front-runner to be the next U.S. Trade Representative. As I explain in the current issue of World Politics Review (subscriber only), the Obama administration has quietly developed an ambitious trade agenda, including the Trans-Pacific Partnership, a proposed U.S.-European free trade agreement, and new talks on services and information technology liberalization at the World Trade Organization. Froman said that the only way these and other trade initiatives can move forward is if we recognize and respond to the distributional consequences of freer trade. Many of the Obama administration’s core policy ideas – more progressive taxation, increased infrastructure investment, expanded college access, job retraining, attracting foreign investment – can be seen as efforts to spread the benefits of globalization more widely. But most of these initiatives have won little support in Congress. The Peterson Institute conference was subtitled “The Tradeoffs Underlying Our Policy Choices.” The dictionary definition of a trade-off is “the relinquishment of one benefit or advantage for another regarded as more desirable.” The question about the the current form of globalization remains: more desirable for whom?

A new study released this week by the Pew Center for the States is further proof of the folly of state tax incentives as a way to attract job-creating business – though in its usual even-handed fashion Pew is careful not to say as much. The report shows that surprisingly few states make serious estimates of the potential cost of tax incentives they offer companies, and very few cap the total benefits, leaving the government exposed to large losses. The results can be shocking. According to Pew, Louisiana’s tax break for horizontal oil and gas drilling, which cost just $285,000 in 2007 before the technology was fully developed, cost the state $239 million in 2010. Hawaii’s tax credits for renewable energy leapt from $34 million in 2010 to an estimated $260 million next year. In the wake of last week’s New York Times series cataloguing the roughly $80 billion in tax incentives and other subsidies to business over the past five years,  I’ve been looking further into whether anything sensible can be done to save state and municipal governments from themselves. It turns out there was one half-hearted attempt, led by former Illinois Republican governor Jim Edgar, as the economy was just coming out of recession in the early 1990s. The catalyst was an out-of-control competition to win construction of a new aircraft maintenance facility by United Airlines. Some ninety cities competed for the $800 million investment, which promised 6,300 jobs paying an average of $45,000 per year. Indianapolis won, with a combined incentives program that added up to $294 million, beating out both Colorado and Kentucky which had actually come up with even larger packages. The AP’s 1992 account of the fight is so good that it’s worth quoting at length: The other finalists felt they’d lost a no-limit, stare-you-down poker game; though others offered higher bids, United chose Indianapolis due to the mix of incentives, location and other factors. Colorado topped out at $340 million. House Majority Leader Scott McInnis grumbled that “United has a ring and is pulling Colorado by the nose.” Kentucky folded in its hand at $341 million in cash, land and tax abatements. Gov. Wallace Wilkinson said United wanted to “prolong it to the point where they were sure they had squeezed every drop of blood out of every turnip.” [End Quote] Robert  Reich of Harvard, who was later to be appointed as President Bill Clinton’s labor secretary, was quoted saying that “the competition is getting out of control.” You think? The AP story added: “When times are tough, a certain desperation enters into the bidding. The competition is cut-throat. And good sense goes out the window.” Indiana won the battle despite facing large state and local budget deficits, in effect forcing the state to raise other taxes or cut services to attract United. The ironic upshot was that United remained for barely a decade, leaving and consolidating its maintenance operations in San Francisco when the airline ran into financial trouble in 2003. And even before United left, the facility never created anything like the promised 6,000-plus jobs, instead topping out at about 1,200. Governor Edgar of Illinois, whose state was one of the fortunate losers in the bidding war, tried to persuade his fellow governors to take a serious look at what he later called “this whole smokestack chasing business.” He never got very far. The closest was a sort of truce among New York, New Jersey, and Connecticut not to run ads aimed at luring away business from their neighbors. Gov. Edgar later argued that states were making a big mistake showering tax subsidies and other goodies on companies. Much better, he said, to focus on improving the quality of life in your state and make it somewhere that smart people want to live and work – much as my colleague Jonathan Masters noted in his post earlier this week on Oklahoma City’s wildly successful revitalization. A better role role for government, Edgar said, is to focus on infrastructure and job training. “I’m not in favor of giving tax incentives or cash or these kinds of things,” he said. “I want something that if you [the company] decide to walk, we’re going to be able to keep. Infrastructure we keep, and a better workforce we keep.” That is much the same conclusion that economist Roland Stephen reached earlier this year in his superb Renewing America working paper, “After Manufacturing: Lessons for a New Reality from North Carolina.” More states should start listening.

Two decades ago, the United States demanded that other countries in the World Trade Organization (WTO) agree to significant restrictions on “trade distorting subsidies” of various sorts, such as government grants, tax breaks, or other benefits that would allow companies an unfair advantage against others in the international market. All well and good, but as the proverb has it: “Physician, heal thyself.” According to a remarkable new database of state government subsidies to business compiled by the New York Times, the fifty state governments are currently offering more than $80 billion each year in incentives to persuade companies to locate or expand in their states. The subsidies take many forms, but the most common are special reductions in taxes to well below the rates that are paid by other companies in the state. While the existence of such location incentives is hardly a secret, the numbers are shockingly large. Texas tops the list, spending more than $19 billion per year on corporate subsidies, and some forty-eight companies, led by General Motors, have received more than $100 million in subsidies since 2007. The subsidies are hard to defend on any rational grounds. The costs in lost tax revenue are significant – Texas last year slashed $31 billion in spending to close its budget deficit, including a 13 percent cut to a public education system that was already among the most poorly funded in the nation. There is no net benefit to the country – most of the companies are either relocating from other states or would have built new operations somewhere in the United States regardless. While the incentives do sometimes lure investment away from other states, in many cases companies would have made the same decisions regardless, so the state government is simply wasting taxpayer money. And in other cases, as the Times documents, the companies quickly pick up and leave when business conditions change or a better offer comes along. While the collective impact is harmful, it is easy to understand why such practices persist. If every other state is offering such incentives, it is hard for a few states to take the moral high ground and refuse to play the game. The promise of new jobs – however costly and perhaps fleeting – is a powerful motivator for any state, especially in a weak economy like the one that still persists. Subsidies wars are economic foolishness, which is why the United States has tried to so hard to use the WTO and other international trade rules to restrict them in global trade. Some of the subsidies identified in the Times’ database could probably be fodder for WTO dispute settlement cases. A number of the largest recipients – including GM, Ford, General Electric and Boeing are either big exporters or compete with imports. The issue of state subsidies, indeed, has been one of the big ones in the long-running Airbus-Boeing dispute in the WTO. But a successful WTO case demands that some foreign country prove that its companies have been harmed by the U.S. state subsidies. In most cases, the only victims here are other taxpayers, recipients of state government services like public education and Medicaid, and the states that lose the bidding wars. It’s time to create a domestic counterpart to the WTO dispute settlement system in order to bring the subsidies wars to a halt. The principles are already well laid out in the WTO, and the European Union has long had its own internal procedures for restricting what it calls “state aid” that distorts competition within the EU. The United States, in striking contrast, has no regulatory regime restricting state or local subsidies. There are three basic requirements: a legislative framework, an adjudication body, and penalties. Legislation:  The U.S. Congress should pass legislation that puts in place domestically many of the rules of the WTO’s “Agreement on Subsidies and Countervailing Measures.” The bill would distinguish between prohibited “specific” state subsidies to companies – such as tax refunds or reductions, cash grants, loans or loan guarantees – and permitted government expenditures such as infrastructure, job training, or across-the-board corporate tax reductions that are broadly beneficial to business. Adjudication:  The federal government should establish dispute settlement panels, under the authority of the Federal Trade Commission. States would be allowed to bring complaints in cases where they believe they have been harmed by prohibited subsidies offered by other states. Much as in the WTO, panel decisions would be binding, though an appeal mechanism to domestic U.S. courts would need to be created. Penalties:  The most obvious remedy is that the tax break or other prohibited subsidy would need to be withdrawn immediately. In the EU system, there is also a provision that can require the companies to pay back the subsidies. Another possibility could be a cash penalty that the offending state must pay to other states that were harmed by its actions. The particulars would obviously take a lot of negotiation, and there may be constitutional issues, though this would seem to fall clearly under the federal government’s power to regulate interstate commerce. But the politics should be easy – Democrats should readily favor an end to corporate tax breaks that rob state governments of revenue, while Republicans should readily support an end to government interference that distorts competition in the market. While some states would protest, and the beneficiary companies would surely object, there would be benefits all around. The states would stop wasting money they don’t have to waste, and the companies could get back to focusing on making quality products at reasonable prices rather than lobbying state governments for sweetheart deals.

Grover Norquist, the anti-tax crusader, has famously said that he has no wish to eliminate government, but only to “shrink it to the size where we can drown it in a bathtub.” Americans up and down the east coast can be grateful in the wake of Hurricane Sandy that he has not yet succeeded, or they might well have drowned in their own homes. For those who wonder just what it is our tax dollars pay for, consider just a small list of government actions before and during the storm that made it far less catastrophic than it might have been: The Commerce Department’s National Oceanic and Atmospheric Administration, which is responsible for tracking the path of hurricanes and other storms, predicted days in advance – and with astonishing accuracy – both the path and strength of Hurricane Sandy. That gave governments throughout the region time to plan a response. New York City Mayor Michael Bloomberg ordered the evacuation of nearly 400,000 people from low-lying areas of the city, and set up emergency shelters. That order probably saved countless lives given the heavy flooding in Lower Manhattan that came at the peak of the storm. New York Governor Andrew Cuomo shut the city’s subway, rail, and commuter buses. The record storm surge led to severe flooding in seven subway stations, the worst in the system’s 100-year history. But no one was hurt in the empty stations. New Jersey Governor Chris Christie ordered the evacuation of Atlantic City and shut the region’s casinos to keep people away from the dangerous coastline. In neighborhoods everywhere, like my own in Maryland, county and city governments provided constant updates on road conditions, dangerous wires, downed trees, and other hazards, and advertised available shelters for those who lost power or had storm damage to their homes. In the aftermath, the Obama administration quickly declared the hardest hit areas of New York and New Jersey to be disaster areas, freeing up millions of federal dollars for temporary housing and repairs to homes and businesses. This list could be much longer, but each represents a success born of planning and coordinated action to improve outcomes for large numbers of people – exactly what governments can and should be doing. The contrast with the failed preparation and response to Hurricane Katrina in 2005 is striking.  In the years prior to Hurricane Katrina, the Louisiana Army Corps of Engineers had identified some $18 billion in projects necessary to shore up the levees in New Orleans against hurricanes and flooding. Instead, Army Corps funding in the state was cut in half in the four years before the 2005 hurricane, with predictable consequences. Both federal and state governments failed to preposition supplies as the storm barreled in, there was little pressure on local residents to evacuate, and emergency responders took days to get to the scene after the storm to rescue the tens of thousands stranded in the city. The vastly improved response this time around shows that governments – like private businesses – can learn from past mistakes. Governor Christie of New Jersey praised the federal government’s response to Hurricane Sandy, calling it “outstanding.” There are some basic lessons in all this. First, we should invest in government services because we want them to be there when we are in a time of need.  Whether it’s a natural disaster that affects millions or a company closure that leaves hundreds out of work, government has the resources to help people get back on their feet and start over. Secondly, governments – like businesses or individuals – can learn to do things better. The preparations for Hurricane Sandy would likely have been much poorer if not for the lessons from Katrina, from Irene, and from this past summer’s “derecho” storms in Washington. Third, the effort to pit state and local governments against the federal government is mistaken; when a genuine crisis hits, we need all three working effectively and in concert. As with all such disasters, human memory is short. Most of us will quickly forget Hurricane Sandy, move on with our lives, and grumble about high taxes. But if we keep letting them do their jobs – rather than continuing to cut them down -- our governments will be busy preparing for the next time we really need them.

The U.S.-China Business Council’s just-released survey on the environment for U.S. companies doing business in China is far more striking for what it doesn’t say than what it does. Of the top ten problems for business in dealing with China, there is no mention of tariffs, or quotas, or even of China’s undervalued currency, which has featured so prominently in the presidential election campaign. Instead, the problems are things like licensing approvals, intellectual property theft, foreign investment restrictions, competition with state-owned enterprises, and unfair regulatory standards. The result should not be surprising, however. In a new Renewing America working paper, Freeing the Global Market: How to Boost the Economy by Curbing Regulatory Distortions, Shanker Singham, a lawyer with extensive experience in both trade and competition law, argues that the traditional trade liberalization agenda as it has existed for more than half a century is now basically irrelevant for the challenges of trading with and investing in China and many other emerging market countries. Instead, he argues, the United States must tackle the growing array of “anticompetitive market distortions” (ACMDs) in these countries – government actions that favor a select group of domestic companies at the expense of both foreign and domestic rivals, and to the detriment of their own consumers. These market distortions come in all shapes and sizes, from advertising restrictions that make it difficult for new competitors to find customers to technology standards that favor domestic champions over their foreign rivals. China developed a homegrown wireless standard, for instance, and assigned it to state-owned China Mobile, which controls two-thirds of the domestic market. U.S. companies like Apple and other international competitors using the more generally accepted global standard have struggled, as a consequence, to break into what has become the world’s largest smartphone market. Such issues are a growing source of tension in the U.S.-China trade relationship and in dealings with countries like India, Brazil, and Russia. But the U.S. government has only been nibbling around the edges of this agenda. Intellectual property protection – which features in all of the trade deals concluded by the United States -- is a high priority, though enforcement remains an enormous challenges. The bilateral U.S. China Strategic and Economic Dialogue and the Joint Commission on Commerce and Trade are addressing a range of regulatory, licensing, and standards barriers. And the United States has made the issue of state-owned enterprises part of the current Trans-Pacific Partnership (TPP) trade negotiations, though little substantive progress has been made on the issue. But Singham argues that such incremental efforts simply do not get at the root of the problem. He calls for a series of new initiatives that would reduce these ACMDs and strive to build freer, more competitive markets around the world. These efforts should include: new international negotiations to build a set of rules to restrain such market distortions and provide benefits to countries that join; bilateral dialogues that bring together trade and competition officials; and if necessary unilateral action by countries to offset the harm caused to their industries by competitors that benefit from ACMDs. There is certainly self-interest in this agenda – many of the most competitive U.S. industries, such as the biotechnology or software industries, are ones that depend on an unbiased and transparent regulatory market in which intellectual property is protected. But there are also enormous potential gains for consumers in developing countries, who face higher costs and enjoy lower quality goods as a result of government measures that discourage competition in the marketplace. What Singham is proposing is a larger agenda that could be used to organize trade liberalization efforts for the next generation. In place of current approach, which still focuses on removing discrete import barriers, he calls for a new effort to build competitive markets around the world. Unleashing such market competition, he argues, would create far more additional wealth globally than even the most optimistic estimates of traditional trade negotiations like the Doha Round. The proposals are certainly ambitious, but the problems are ones that require an ambitious response. The alternative is an ever growing gulf between the problems facing U.S. companies doing business around the world and the U.S. government’s ability to resolve them.

It did not take long for the verdict to be reached on the first face-to-face debate of the campaign: President Obama's performance was about as lackluster as the current state of the U.S. economy. It may not matter much to the final election outcome, but his inability to make a stronger case for his economic management highlights one of the disadvantages of incumbency  -- that governing is a chastening experience. Candidates run on a set of optimistic and essentially unprovable theories about how the economy might respond to their favored medicine. Sometimes they get lucky, as Presidents Reagan and Clinton did. But more often they run for re-election knowing that their theories are unlikely to survive the stubborn challenges that await. President Obama has learned what my CFR colleague Michael Spence has called "the hard truths about global growth" -- that incomes for the middle classes in the advanced economies are likely to remain stagnant for some time, that growth is likely to be modest as deleveraging continues, and that governments face an almost zero-sum choice among financing consumption, financing investment, or bringing deficits under control. Thus much of Obama's pitch was about the difficult decisions he believes must be faced, which involve raising at least some taxes and cutting at least some consumption, especially through cost controls on Medicare, to finance investments in education and infrastructure that will not pay off anytime terribly soon. In contrast to that dour message, Mitt Romney was able in the debate -- in a way he had not really done in the campaign -- to capture the edge in optimism. His economic platform boils down to the hopeful prediction that an overhaul of the tax code and the rolling back of certain Obama era regulations (health care, much of the Dodd-Frank financial legislation, restrictions on energy exploration on public lands, etc.) would unleash a new era of stronger growth that will make the hard choices avoidable. While Romney's running mate, Paul Ryan, has sketched out a budget plan that would actually make deep cuts in government spending on the poor and elderly, Romney steered clear of those sorts of specifics. Instead, he promised that robust growth created by a revenue-neutral tax overhaul and some regulatory tweaking would keep the deficit under control, free up more money for Medicare and allow him to boost military spending, while making only modest cuts to the most obviously wasteful or unnecessary government programs. The reality, of course, is that Romney's plan would almost certainly allow nothing close to that. Nor, for that matter, would President Obama's plan to let taxes on the wealthy to revert to Clinton-era levels suddenly ignite Clinton-era growth rates. Either will confront an economic and fiscal situation in which any of the plausible choices are difficult ones. Optimism has long been an American trait, and certainly Romney's political advisers must be delighted that he has finally tapped into it. Yet the polls at the moment still give an edge to the president, who is asking voters for patience while the economy slowly crawls out of worst economic crisis in three-quarters of a century. There is a great irony, to be sure, that the candidate of hope and change has now become the candidate of incremental progress and tough decisions. But governing requires a sense of irony. It helps for coping when the promises don't work out quite as planned.

In an era in which companies enjoy unprecedented mobility to invest where they choose, one of the toughest issues for governments at the federal, state, and local level  is deciding what to do to attract and retain those investments. Governments should want to compete for investments that bring jobs, spin-off businesses, and tax revenue. And corporations – often with many suitors -- can and do demand tax breaks, cheap energy, help with training programs, improvements in road and air access and other favorable legislation, and regulations that only governments can supply. But what do the companies owe in return? Too often, it seems, they believe the answer is nothing. The aerospace giant Boeing, which is the largest exporter in the United States, used every one of its considerable political chits in Washington to wrest away from Airbus a $35 billion contract for Air Force refueling tankers. It enlisted, among others, the powerful Kansas senator Pat Roberts (R-KS) by promising that the contract would help save jobs in Wichita. Then earlier this year, the company announced that it would close its Wichita plant and move the work to several other states, citing cutbacks in defense spending. More than 2,100 employees in Wichita will lose their jobs next year. State Representative Mike Pompeo (R-KS) said that while Boeing had every right to move the work, it “will indeed break years and years of promises” to the state. But it’s hard to top the behavior of Microsoft in the tiny farming community of Quincy in Washington State. Microsoft is a great company, an iconic capitalist success story much like Boeing. It was the world’s leader in the development of personal computer operating systems, which did more than any other single product to drive the productivity gains of the past two decades. Its founder Bill Gates has become one of the most influential philanthropists of this or any period in U.S. history, on a par with the Rockefellers and the Fords. But his company’s behavior in Quincy, as reported by the New York Times over the weekend, was more reminiscent of Al Capone. The county, eager for tax revenue and jobs, agreed to offer reliable hydroelectric power at less than half the prevailing national cost so that Microsoft could establish a huge data farm to power its Bing search engine. Microsoft committed to using a certain quantity of power, and the local utility agreed to set aside that power and not sell it to other customers to ensure there would be no shortage for the data center. Near the end of last year, Microsoft received a notice from the county utility that it would be fined $210,000 for over-estimating its power needs, a mistake that prevented the county from re-selling the power. Yahoo, which also runs a server farm in the town, similarly over-estimated and quietly paid its $94,608 penalty. But Microsoft instead began to burn power furiously in what it admitted was a “commercially unproductive” manner, and warned that it would continue doing so unless the county lowered the fine.  The utility board caved in during a special weekend session and agreed to lower the fine to $60,000. These are not isolated examples. Instead, they are the unsurprising result of a growing power imbalance between corporations and governments. Much as Caterpillar – another great American company – could force a six-year wage freeze on its Joliet, Illinois employees. These companies know they hold the cards. States and communities are so desperate for business investment that they will agree to almost anything to secure and retain it. Can anything change this imbalance? The Harvard Business School's Competitiveness Project earlier this year made an appeal for enlightened corporate behavior, encouraging companies to invest in the “commons” – by expanding training, working with local suppliers, and lobbying governments for “business-wide improvements” rather than special interest advantages. While these goals are laudable, and there are plenty of examples of such responsible corporate action, they are unlikely to move the needle very far. Instead, governments are going to have to rediscover their sources of leverage. Companies like Microsoft, Boeing, and Caterpillar want many things from governments. At the national level, these include better protection of their intellectual property, support in trade and investment disputes, and favorable immigration rules. At the state and local level they include university and community college education and training, support for research and development, and investment in roads and rails. Corporations want a profitable location to do business; governments want a commitment to the communities they represent. In future posts, I will start to sketch out ideas on how both interests might be better served.

The world’s high-income countries are in economic trouble, mostly related to growth and employment, and now their distress is spilling over to developing economies. What factors underlie today’s problems, and how appropriate are the likely policy responses? The first key factor is deleveraging and the resulting shortfall in aggregate demand. Since the financial crisis began in 2008, several developed countries, having sustained demand with excessive leverage and consumption, have had to repair both private and public balance sheets, which takes time – and has left them impaired in terms of growth and employment. The non-tradable side of any advanced economy is large (roughly two-thirds of total activity). For this large sector, there is no substitute for domestic demand. The tradable side could make up some of the deficit, but it is not large enough to compensate fully. In principle, governments could bridge the gap, but high (and rising) debt constrains their capacity to do so (though how constrained is a matter of heated debate). The bottom line is that deleveraging will ensure that growth will be modest at best in the short and medium term. If Europe deteriorates, or there is gridlock in dealing with America’s “fiscal cliff” at the beginning of 2013 (when tax cuts expire and automatic spending cuts kick in), a major downturn will become far more likely. The second factor underlying today’s problems relates to investment. Longer-term growth requires investment by individuals (in education and skills), governments, and the private sector. Shortfalls in investment eventually diminish growth and employment opportunities. The hard truth is that the flip side of the consumption-led growth model that prevailed prior to the crisis has been deficient investment, particularly on the public-sector side. If fiscal rebalancing is accomplished in part by cutting investment, medium- and longer-term growth will suffer, resulting in fewer employment opportunities for younger labor-market entrants. Sustaining investment, on the other hand, has an immediate cost: it means deferring consumption. But whose consumption? If almost everyone agrees that more investment is needed to elevate and sustain growth, but most believe that someone else should pay for it, investment will fall victim to a burden-sharing impasse – reflected in the political process, electoral choices, and the formulation of fiscal-stabilization measures. The core issue is taxes. If public-sector investment were to be increased with no rise in taxation, the budget cuts required elsewhere to avoid unsustainable debt growth would bein implausibly large. The most difficult challenge concerns inclusiveness – how the benefits of growth are to be distributed. This is a longstanding challenge that, particularly in the United States, goes back at least two decades before the crisis; left unaddressed, it now threatens social cohesion. Income growth for the middle class in most advanced countries has been stagnant, and employment opportunities have been declining, especially in the tradable part of the economy. The share of income going to capital has been rising, at the expense of labor. Particularly in the US, employment generation has been disproportionately in the non-tradable sector. These trends reflect a combination of technological and global market forces that have been operating over the last two decades. On the technology side, labor-saving innovations in network-based information processing and transactions automation have helped to drive a wedge between growth and employment generation in both the tradable and non-tradable sectors. In the tradable part of advanced economies, manufacturing automation – including expanding robotic capabilities and, prospectively, 3D printing – has combined with the integration of millions of new entrants into rapidly evolving global supply chains to limit employment growth. Multinational companies’ growing ability to decompose these global supply chains by function and geography, and then to reintegrate them at ever lower transaction costs, removes the labor-market protection that used to come from local competition for workers. This challenge is particularly difficult, because economic policy has not focused primarily on the adverse distributional trends arising from shifting global market outcomes. And yet the income distributions across advanced economies, presumably subject to similar technological and global market forces, are, in fact, startlingly different, suggesting that a combination of social policies and differing social norms does have a distributional impact. Although the theory of optimal income taxation directly addresses the tradeoffs between efficiency incentives and distributional consequences, the appropriate equilibrium remains a long way off. A healthy state balance sheet could help, because part of the income flowing to capital would go to the state. But, with the exception of China, fiscal positions around the world are currently weak. As a result, deleveraging remains a clear priority in a range of countries, reducing growth, with fiscal countermeasures limited by high or rising government debt and deficits. Thus far, there is little evidence of willingness on the part of politicians, policymakers, and perhaps the public to reduce current consumption further via taxation in order to create room for expanded growth-oriented investment. In fact, under fiscal pressure, the opposite is more likely. In the US, few practical measures that address the distributional challenge appear to be part of either major party’s electoral agenda, notwithstanding rhetoric to the contrary. To the extent that this is true of other advanced economies, the global economy faces an extended multi-year period of low growth, with residual downside risk coming from policy gridlock and mistakes in Europe, the US, and elsewhere. That scenario implies slower growth – possibly 1-1.5 percentage points slower – in developing countries, including China, again with a preponderance of downside risk. This article originally appeared at www.project-syndicate.org.

The World Economic Forum’s annual Global Competitiveness Report is the closest thing that exists to a Michelin Guide for national economies. And in a world where businesses looking to establish or expand are perfectly free to choose, say Germany over Canada or Vietnam over China, the report is a helpful cheat sheet. And its latest take on the United States would probably cost us a star. The World Economic Forum is best known, of course, for its annual January gathering in Davos, Switzerland of the world’s economic and political elites. For those of us not invited behind the closed doors, the report offers a snapshot of what they are thinking. While the rankings are based in part on objective factors like government debt, market size or patents issued, most of the numbers that decide the rankings are derived from an annual survey of some 15,000 business executive worldwide. The survey is not as useful as the one undertaken earlier this year by the U.S. Competitiveness Project at Harvard Business School, which looked at hundreds of actual  corporate location decisions by business executives in multinational companies. But it still offers some insights into what corporate executives believe are the best places to do business, and why. And in a world of mobile capital, that matters a lot. What does business thinks about the United States? Less and less it seems. The United States remains among the most competitive economies in the world, and among large economies is rivaled only by Germany (6th), the UK (8th) and Japan (10th). But it continues to lose ground, falling two places in this year’s report, from 5th to 7th overall. As recently as the 2008-09 report, the United States was at the top of the rankings, and had been for several years prior to that. The gripes from business leaders have not changed very much over that period. In 2008, the “most problematic factors for doing business” in the United States were tax rates, tax regulations and inefficient government bureaucracy, in that order. The same three still topped the list this year, but government regulation had nudged its way to the top. Interestingly, in 2008 the next biggest concern was an “inadequately educated workforce,” probably reflecting the tight labor market prior to the financial crisis that made finding the right employee difficult. Since then, concern over workforce education has fallen by more than half, probably because high unemployment allows companies to be a lot choosier. Drilling down a bit deeper, it’s pretty clear that business executives – at least the sort who fill out the Forum’s survey -- are not very happy with the U.S. government. Their “trust in politicians” has dropped markedly, and there is growing concern about the burden of government regulations and the wastefulness of public spending. On both the objective and subjective measures, it is clear from the report that the biggest problems in the United States are institutional problems of one sort or another. The relationship between government and business is fraught, the quality of infrastructure is inadequate and slipping, and the macroeconomic environment is deteriorating, largely because of the government’s inability to manage its finances. The good news is that, while there has been some slippage, the United States continues to be near the top on measures of business sophistication and innovation, which are the key drivers of success for wealthier countries that must constantly develop new and better goods and services to maintain their economic edge. As the report summary notes, “U.S. companies are highly sophisticated and innovative, supported by an excellent university system that collaborates admirably with the business sector in R & D.” The differences among countries on the index are often extremely small, so the falling U.S. ranking could be nothing more than a temporary dip that will be righted when the economy starts to grow more strongly. But for the moment, at least, the arrow is going in the wrong direction.

Are government regulations stifling the U.S. economy? Unfortunately the answer to that question, even outside the electoral silly season, rarely goes beyond a simple, and usually partisan, yes or no. So it was probably inevitable that the release this week of a rather sophisticated economic study by the Manufacturers Alliance for Productivity and Innovation (MAPI) generated predictable headlines about the costs of regulation weighing down the U.S. economy. And as the research and education arm of the big U.S. manufacturers, MAPI was probably perfectly happy with that reading -- which is unfortunate, because the study, conducted by NERA Economic Consulting, contains a wealth of interesting data to help assess the cost of regulations. My reading of the bottom line: the burden of federal regulation has grown substantially over the past three decades, with real costs to U.S.-based manufacturing, and continues to grow. But the most costly regulations are those designed to improve air quality, reduce energy consumption, and ensure safe working conditions – goals the public generally favors. In the abstract, government regulation is one of the more divisive issues in public opinion. The recent, and immensely useful, Pew Values Survey, asked the public if “government regulation of business does more harm than good.” Seventy-six percent of Republicans agreed, versus just 41 percent of Democrats. Among Tea Party Republicans, 87 percent thought government regulations were harmful, versus just 32 percent of liberal Democrats. On a related question, four out of five Democrats agreed with the statement that a “free market economy needs regulation to serve the public interest”; Republicans were evenly split. Source: Pew Research Center But when it comes to specific regulations to promote certain goals, they are surprisingly popular among all Americans. A Pew survey from February 2012 found that 89 percent of Americans (including 77 percent of Republicans) believe regulations on food production and packaging should be maintained or strengthened. On car safety and efficiency, 87 percent of Americans (and 82 percent of Republicans) say the same. On workplace safety, 86 percent of Americans (and 77 percent of Republicans) want to maintain or enhance regulations. The only real skepticism is over environmental regulations, but even here 79 percent of all Americans (and 59 percent of Republicans) are in favor of regulation. Source: Pew Research Center The real question raised by the new study is whether the costs of those measures are reasonable ones, and whether the gains in overall public welfare are worth the expenses foisted on particular industries. Most Americans would be untroubled, I suspect, by the report’s finding that the chemical and petroleum sectors are the ones paying the highest costs for regulation. These are industries that have the potential to do real environmental damage if not properly regulated. The agency that issues the greatest number of regulations is the Department of Agriculture, which is charged with protecting the U.S. food supply. The two regulations that impose the highest costs overall are a pair of 1998 Environmental Protection Agency measures to reduce ozone and particulates in the air. The people of Los Angeles say “thank you very much.” But it does not follow that more regulation is always better, and in recent decades we have been seeing steadily more federal regulation (though alongside deregulation of certain industries like airlines and telecommunications). During the Clinton administration, the average number of major regulations  -- those with an economic impact of more than $100 million -- enacted each year was thirty-six. During the Bush administration that rose to forty-five per year. In the Obama administration it has been seventy-two each year. And while it says more about an anemic economy than runaway regulation, the inflation-adjusted compliance costs for manufacturers have risen on average 7.6 percent each year since 1998, compared with average annual GDP growth of just 2.2 percent, and manufacturing output growth of only 0.4 percent. Given the other competitive challenges facing U.S. manufacturers, escalating regulatory costs are clearly a problem. The study drew a predictably angry response from consumer and environmental groups, which called it "pure hokum." They rightly pointed out that the study did not attempt to calculate whether the public benefits of regulation have outweighed the costs to industry. That, of course, was not its purpose. Unfortunately buried in a footnote to his executive summary, the president of the Manufacturers Alliance states: This study does not address the benefits related to regulation. MAPI recognizes the need for regulation to protect the health and safety of the population and to protect the environment. Our goal is not to argue for the elimination of regulation but to describe and quantify the substantial cost of federal regulation to manufacturers, and to provide a framework for a rational evaluation process so the economic benefit of the rules clearly exceed the cost and American manufacturing competitiveness is not hampered. I would add that other, not purely economic, benefits such as improved health and a cleaner environment, need to be considered as well. But the study is certainly a useful starting point for a serious discussion of the trade-offs involved in government regulation.

The 2010 Dodd-Frank Act was one of the most significant financial regulatory reform measures since the Great Depression.  In the wake of the financial crisis, it sought to give regulators new tools to limit risky behavior and address systemic risk.  After two years, its implementation is still ongoing; many major rules have not yet been written. In this CFR Backgrounder, The Dodd-Frank Act, Renewing America contributor Steven J. Markovich examines the financial oversight bill, and the debate over its methods, goals, and implementation.

The dragging U.S. economic recovery was dealt another blow after jobs data for May, released June 1, showed an increase in the unemployment rate to 8.2 percent (CBS). The U.S. economy is simultaneously facing mounting external pressures related to the ongoing eurozone sovereign debt crisis and a growth slowdown in the developing world. In the following CFR.org interview with Christopher Alessi, CFR's Distinguished Visiting Fellow A. Michael Spence says, "You have extreme uncertainty and macroeconomic risk in the global economy, which shows up in volatility in a variety of financial markets." He notes that this climate "causes conservative behavior on the consumption and investment side." Spence also faults Washington for continued political gridlock. "There isn't very much aggressive public policy or public investment action, even taking into account the constraints of a sensible fiscal rebalancing program." Can you give an overview of the U.S. economic picture in light of the May jobs report? There [are] two things going on in the American economy post-crisis. One is deleveraging--leveraging up was an aspect of the dynamics that went into the crisis. That's fairly far along, depending on which sectors you're talking about. There are still issues, and the housing market's not helping. The other is structural adjustment of the economy, and that involves both demand and supply-side changes--so the demand side is going to have to eventually rely on a different mix of domestic demand and external demand and a different mix of investment and consumption. There are signs of market-driven structural adjustment. Wages and incomes are flat. There are some bits of evidence that manufacturing is recovering, and even manufacturing exports are getting a little more competitive. Exports have actually grown above their pre-crisis levels, and imports have not grown the same amount, so the current account deficit is coming down. So all of this is a lengthy process with a really big problem on the employment side, because underneath it all are all these labor-saving technological and global market forces. You've got a double problem: to pay for past excesses and try to invest in things that will generate growth and employment in the future. Employment was always going to be a struggle because of these global forces. We really haven't had a recovery in the construction sector, which is labor-intensive and important. And finally, nothing much is happening in Washington. There isn't very much aggressive public policy or public investment, even taking into account the constraints of a sensible fiscal rebalancing program that would make the restoration of a sustainable pattern of growth, employment, and momentum faster, and the quality of the result better. What policy prescriptions would you recommend the U.S. take to alleviate the employment piece and the larger economic situation? I don't believe you can solve a structural problem overnight. By structural, I mean where it generates employment, where it's competitive on the tradable side. If you've taken a terrific wallop, in part because you were in a defective growth path--meaning one that's self-limiting, can't go on forever, and includes overconsumption and leverage--then you've got a double problem: to pay for past excesses and try to invest in things that will generate growth and employment in the future. That's a pretty big burden, and it's a hard problem, but the main thing is you've got to decide how the burden gets shared. We have to find a somewhat fairer way to share the burden rather than just impose it on the unemployed, especially the young--redistributing income to the extent we can, going after skills upgrading and retraining. The political process [involves sitting down and deciding] who's going to pay the bill. If you don't do anything, then the unemployed pay the bill. We have to find a somewhat fairer way to share the burden rather that just impose it on the unemployed, especially the young, redistributing income to the extent we can [and] going after skills upgrading and retraining. You want to plan to invest in infrastructure. We need a change in attitudes about labor [that encourages investment in the labor sector by focusing skills and job training]. Tax reform would be a good thing that doesn't necessarily cost money. How is the United States being affected by the eurozone crisis and the slowdown in the developing world? Adversely. Europe is our biggest trading partner, so the slowdown in Europe is a direct negative effect. The emerging economies are an important growth engine, so their slowdown is not positive either. Then you have extreme uncertainty and macroeconomic risk in the global economy, which shows up in volatility in a variety of financial markets--exchange rate volatility, the Asian stock markets are highly volatile, and even ours is even relatively volatile. All of this has created uncertainty, and that then causes conservative behavior on the consumption and investment side, so that doesn't help either. There's nothing that's happened yet that's a massive hit to the American economy, but it doesn't help that everybody is slowing down at the same time. What policy prescriptions would you give for the eurozone situation? Greece may or may not decide to exit. That can cause contagion that's sort of similar in general terms to the contagion that occurred in the Asian crisis in the late 1990s. That has to be contained or it could get out of hand, and that means deploying the European funds [the European Financial Stability Facility and the European Stability Mechanism] and the ECB to stop it. They have to stop it on two sides: the banking side to prevent financial distress, but also on the sovereign debt side. Properly responded to, Greece does not have to bring down the eurozone. There's nothing that's happened yet that's a massive hit to the American economy, but it certainly doesn't help that everybody is slowing down at the same time. Italy and Spain are large, and they both need fiscal rebalancing and reforms that are designed to restore their growth, and those go together. It's hard to restore stability and balance on the fiscal side without some growth momentum. What will make this go wrong is if the political systems in Spain and Italy turn against the euro and reform process and say, "We don't want to play this game, we're going to play another game." Then the game is over with respect to the eurozone as it was envisaged. What's the next step in coordinating a coherent response to the debt crisis? These reforms take time to take effect. Even if they're getting it done, there's a risk that the yields will run up, because private investors are still uncertain and afraid and not really investing. Most of the money that goes into European sovereign debt is going into the German sovereign debt and a little bit in the Nordic countries. So Germany and the ECB are very reluctant to intervene in the sovereign debt market. But I believe that they will intervene to prevent a flip to a bad equilibrium, where expectations shift the mark, the yields run up, it destroys effectively all the fiscal consolidation that's been done, and eventually shifts the incentives of the countries that are in trouble or need rebalancing. The ECB has a mandate to intervene in the banks to prevent extreme financial distress. They have done that on a fairly massive scale, and they're prepared to do that again--but their willingness to do that is heavily based on serious commitment to reform in these countries. So it's a kind of chicken-and-egg problem.

In the face of persistently high unemployment, innovation and entrepreneurship have historically been the primary engine of U.S. job growth. But that engine has been slowing in recent years. In this CFR Backgrounder, U.S. Entrepreneurship and Venture Capital, Renewing America contributor Steven J. Markovich discusses how entrepreneurs create and finance the startups that power U.S. job growth, and the ramifications of recent policies such as the JOBS Act.