America’s Election and the Global Economy

STANFORD – As America’s elections approach, with President Barack Obama slightly in front of his Republican challenger, former Massachusetts Governor Mitt Romney, pollsters still rate the races for control of the presidency and the United States Senate too close to call, with the House of Representatives likely to remain in Republican hands. The differences between the candidates are considerable, and highly consequential for American economic policy and the global economy, although enactment of their programs will depend on the makeup of Congress. The most important differences between the two candidates can be summarized as follows:

Spending. Obama has dramatically increased spending. He would likely continue many of his temporary programs (as Milton Friedman once observed, “There is nothing so permanent as a temporary government program.”); double down on having government pick winners and losers in green energy; expand spending on education and infrastructure; and substantially reduce defense expenditures.

Romney, by contrast, favors limiting overall federal spending, currently 24% of GDP, to 20%, and keeping defense at 4%. He wants private markets, not government, to choose winning firms and technologies.

Democrats oppose most nondefense spending cuts, arguing that reductions would cause the economy to contract. That case is strongest if the spending reductions are large and abrupt in a weak economy. If phased in over a multi-year period as the economy recovers, as Romney proposes, thrift would likely be expansionary. For example, federal spending relative to GDP fell by five percentage points from the mid-1980’s to the late 1990’s in the US, and by an even larger margin in recent decades in Canada – that is, through periods of strong economic growth.

Taxes. Obama would raise the top marginal tax rates on wages, capital gains, dividends, interest, and estates, especially on higher-income individuals and small businesses. Yet he has never proposed comprehensive reform of either the personal or corporate income tax.

By contrast, Romney would reduce America’s corporate tax rate (the highest in the OECD) to 25% and tax American multinationals on a territorial, rather than a worldwide, basis in order to increase their tax competitiveness. He would also lower personal tax rates by 20%, and make up lost revenue by limiting tax deductions and credits, particularly at the upper end, thereby raising about 18.5% of GDP, just above the historical average, at full employment. Romney’s fiscal plan thus reduces deficits sufficiently to decrease the debt-to-GDP ratio. He favors a balanced-budget amendment to the Constitution, and hopes to balance the budget over eight years.

Obama, by contrast, would run larger deficits – his spending increase is much larger than his tax increase – which imply large tax hikes in the future. Moreover, he would run far larger debt ratios than Romney, because the main driver of the debt is entitlement spending.

Entitlements. Obama has remained silent about reform of Medicare and Social Security, whose long-run deficits are several times the national debt. Vice President Joe Biden has even said that “no changes” to Social Security are to be made.

Romney supports gradually increasing retirement ages, a premium-support model for Medicare, and shifting Medicaid (health insurance for the poor) to the states via block grants. The Obama campaign is pummeling Romney on Medicare, and the Romney campaign is hammering Obama for his refusal to negotiate or even propose a solution.

The Obama policy would thus lead to ever-higher deficits and debt ratios well over 100% of GDP, a level that numerous studies imply would reduce US economic growth by one-third or more and might induce a sovereign-debt crisis. Some observers suggest that Obama’s unspoken plan is ever-growing entitlements eventually paid for by a European-style value-added tax.

Trade. Obama is the first US president in a long time who has not played a leading role on global trade liberalization. The Doha Round of global trade talks remains stalled, and Obama delayed the three bilateral free-trade agreements that awaited approval when he came into office. Romney is a proponent of free trade, but has said that he would be tougher on China’s trade practices and currency policies.

Regulation. Obama wants to expand federal command-and-control regulation further (though the courts have stopped his extension of some regulatory powers). Romney vows an economically balanced approach that would reform Obama’s major health-care, environmental, and financial-services regulations.

Appointments. Every US president appoints thousands of officials, many with considerable power. Romney has said that he would not reappoint Ben Bernanke as Fed Chairman (likely candidates: economists Glenn Hubbard, Greg Mankiw, John Taylor, and Martin Feldstein). Other presidential appointees exert considerable influence on firms, industries, or the entire economy. For example, Obama’s appointees to the obscure National Labor Relations Board tried to prevent Boeing from expanding in South Carolina, despite the state’s anti-union “right to work” legislation.

These policies would affect US economic growth, the budget deficit, national saving, and hence global trade and capital flows. With larger deficits under Obama than under Romney, America would need more capital from Europe, Latin America, and Asia, while higher taxes and debt would impede US growth and thus undermine these regions’ exports. Obama would steer America in the direction of European social-welfare states; Romney’s agenda is designed to prevent that.

Whoever wins, a fiscal cliff looms at the end of 2012. Previous legislation, if not reversed, will lead to large abrupt tax hikes and spending cuts, which the Congressional Budget Office forecasts would likely cause a recession in 2013. While a post-election, lame-duck session of Congress will address the fiscal cliff, the deep differences between Republicans and Democrats on taxes and spending remain wide and difficult to bridge.

With uncertainty plaguing Europe’s finances and China slowing, the last thing the global economy needs is a stagnant or shrinking US economy. But it will take strong leadership by the president-elect to avoid it.

Copyright Project Syndicate – www.project-syndicate.org