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The Good, The Bad, and The Ugly in the President's State of the Union Address

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President Obama gave a serious and subdued message that relied heavily on an American "can do" spirit by invoking the image of "our generation's Sputnik moment". He spoke of the domestic and international challenges facing our nation as we turn from fighting a deep downturn toward recovery. While I think that the president is far too optimistic on that front, I do not blame him for using this venue to look past the continuing crisis and toward the future. That does make sense for someone who would like a second term and who must now begin to put forth a justification for consideration by a skeptical electorate.

In this brief post I will examine the good, the bad, and the ugly that were on view Tuesday night.

The Good. The president addressed some "big ideas" -- areas that we all know have been largely neglected for three decades in the US. It is interesting that the period of neglect occurred exactly over the time frame that the Soviet Union self-destructed, leaving America as the lone super power. Hence, the president's mention of Sputnik and the challenges raised by China's success rightly highlights our problem: with no rivals, our policy-makers fell asleep at the wheel. We lagged behind almost all other wealthy developed nations in many areas -- health, poverty, inequality, malnutrition of children and infant mortality, education, life expectancy, public infrastructure, crime, transparency of government, and business ethics.

Many times throughout his speech, President Obama roused the crowd with reference to America's greatness. He -- as well as the politicians in attendance -- knows that because most Americans have not directly experienced the much higher living standards that most Europeans enjoy, Washington could long ignore our laggard status as the wealthiest third world country on earth. We are much closer to a Brazil than we are to a France by most of the important measures. Do not get me wrong -- we have very much to be proud of, unfortunately, most of our best moments are now in the very distant past. By almost any measure, US living standards for the vast majority of our population have slipped far behind those of other wealthy nations -- and by many measures we fare no better than countries with per capita incomes far below ours.

But what has awakened the sleeping giant is that China (China!) is eating America's lunch. Yes the land known for overpopulation, starvation, the Cultural Revolution, and communism is overtaking the US. By some estimates (still controversial) on a purchasing power basis China's GDP might already be greater than US production. Even if that is wrong, there is no doubt that the day of reckoning -- when China's output surpasses ours -- is just around the corner. Anyone who travels to modern China cannot help but be in awe at the transformation of the past two generations.

China's business investment is twice as large as the total business investment in the US, Europe, and Japan combined. China has 8500 kilometers of high speed rail; the US has 360. That is not a typo. Japan has 2500 kilometers and Europe has 6600. By 2013 China will have 20,000 km. Again -- no typo. That gives the reader some idea of China's rate of growth. Yes it is true of course that China has five times the population, and it has chosen to rely more on rail than we have. Yet, China's airlines are expanding at a similar rate -- and the airports in China are quite simply stupendous, absolutely first class, and the airlines operate at first world standards -- with a smile, to boot. Further, the Chinese are gobbling up cars as quick as they can be produced -- GM now sells more cars in China than in the US. Clean energy? China increased solar panel production fifty-fold between 2005 and 2010. Believe me, whatever China sets its mind to do, it will do.

So I give the president good marks for focusing on areas that will help to bring the US into the modern age that China increasingly enjoys: investments in research, information, and clean energy; more infrastructure spending, including high speed rail; and education.

The president paid particular attention to the last one -- calling on Americans to serve their country as teachers. While I'm a professor and hence do have a pony in that race, he was not really referring to college teaching. Yes, he did point out that we have slipped to number 9 in terms of college graduation rates, yet he also (rightly) recognized that we have the best system of higher education in the world. I do agree with him that we should try harder to retain foreign students who receive their education here -- those who want to remain. "Brain drain" is a significant problem for developing nations who often send their brightest and most motivated students here, and I like to encourage students to return home. But for those who are determined to stay in the US, the president is right to propose that we should recognize all the benefits of easing their transition into jobs here in America.

What the president was really arguing is that we need to improve elementary and high school education. Kudos to him for openly saying what almost all of us believe: "No Child Left Behind" was at best an empty slogan and at worst an impediment to provision of a decent education. It did not and could not work. The President also said things about quality teachers that resonated well, and something really must be done in that area while protecting the rights of teachers to organize. It is counterproductive to defend and retain bad teachers.

Coincidentally, results from the Nation's Report Card were released on Tuesday. My university's state, Missouri, proudly trumpeted the finding that its students outperformed most of the nation, with 32 percent of fourth graders scoring "proficient or better" in science. In 8th grade, 36% of Missouri students scored at that level, versus 29% for the nation as a whole. By 12th grade, however the percent was 21% in Missouri -- still above the nation's average, but unacceptable. That means nearly 4/5 of Missouri's students are not proficient in high school science by their senior year -- lower than the national average yet a humiliating statistic all the same. That is not world class by any stretch of the imagination. No wonder the US is falling behind in college graduation rates -- students are not prepared for college.

The Bad. There were three troubling things about the President's address. First, focusing on China's success as a justification for finally waking up to our domestic problems really does remind one of Sputnik and the ensuing cold war tactics. It would be extremely unfortunate if a generation from now President Obama's speech would be recalled for the beginning of a new cold war. We should look to China, instead, as an example of what is possible, not as a challenge to a competitive battle. Of course, America should and will take its own approach to development but China proves that the problem cannot be technological or financial. China's financial system is primitive in comparison to ours -- yet it easily manages to finance construction of magnificent train stations, airports, and university cities (yes, I mean cities--with gleaming glass buildings, on-site hospitals, grocery stores and restaurants, faculty housing, and acres of ping-pong tables to exercise the body so that China does not become a nation of obese college grads). In China, the attitude is: if it is technologically possible, it is financially feasible. That is the right way to look at it.

But that brings us to the second problem. The lesson that Obama apparently learns from the Chinese is that exports are the path to development and job creation, hence he proposes to double exports by 2014. That is the wrong lesson. Yes, it is true that China is an exporting powerhouse -- but much of its exports are low value added products, often with components produced elsewhere and assembled by low wage labor in China. From my discussion with Chinese, exports are viewed as a way to improve production methods to enhance quality and productivity. By selling into international markets, the Chinese improve the quality of products they sell at home. Gradually, demand will be shifted from foreign demand for Chinese exports to domestic demand by Chinese consumers with rising income. In other words, this is just a stage that China will pass through.

The US long ago learned how to make internationally competitive output; and the Japanese forced even the lazy American automobile giants to keep up. With a mostly open economy, US producers must produce to high international standards -- they do not need to export to be properly incentivized. Increasing US exports significantly is neither necessary nor possible. The rest of the world wants US dollars and they get them by running trade surpluses against us. If necessary they will bust wages and living standards at home to maintain their exports. The US cannot win in a race to the bottom. And it is not China that we will be running that race against -- Chinese living standards in cities are already too high to compete with newly developing nations.

And that leads to the third problem. The other wrong lesson Obama apparently learned from the Chinese is that exporting nations accumulate huge international currency reserves, enabling them to afford domestic development. That is mostly in the form of US dollars. So, while he says the US is "running out of money", the Chinese are accumulating it. His incorrect understanding is that if the US stopped running budget deficits and trade deficits, it would have more money available to finance his favored package of long term investments in our future. To that end, he wants to double exports, freeze federal government domestic spending, and repeal some of the tax cuts that favor the rich. All of that is on the wrong track.

While I do believe that the US has had a problem with deficits and debts, it was the US private sector not its government sector that created the problem. Perhaps our households and firms "ran out of money", but the government as sovereign issuer of our currency can never "run out of money".

I have explained that before, both on this blogsite as well as at New Economic Perspectives, New Deal, and Benzinga, and also in academic papers at www.cfeps.org and www.levy.org. Let me quickly recap: yes, it is true that our domestic private sector (households and firms) ran budget deficits for most of the decade 1996-2006. That helped to fuel economic growth as well as the housing boom, but it also meant a growing mountain of debt -- including those subprime mortgages that got bundled and sold even to the Chinese. It was unsustainable and crashed in 2007 -- we are now living in the aftermath as the private sector downsized, defaulted on debt, and started saving again.

The earlier private sector deficits helped to reduce the federal government deficits during the Clinton years, and even during the later part of the Bush years (holding the current account balance constant, that is an identity: private sector deficit equals dollar-for-dollar a government surplus). When the private sector retrenched after 2007, the government sector's deficit grew (dollar-for-dollar, excluding the improvement of the current account deficit).

Unlike the private sector's deficit, a government sector deficit is sustainable in the sense that it cannot lead to insolvency; sovereign government cannot run out of finance. That does not mean growing budget deficits are a good idea -- they can boost demand beyond the full employment level, fueling inflation. They might affect the exchange rate; and they might affect the interest rate (although the impact is the reverse of what is usually believed, a point I will not explain here). But none of that is related to affordability.

(Caveat: state and local governments are not sovereign; they do have unsustainable financial positions and hence are cutting spending and raising taxes and fees. That in turn is creating huge head winds that will kill this supposed recovery. A topic for another day.)

On this the Chinese are right: whatever is technically feasible is financially affordable. And that is exactly how they are adding thousands of miles of highspeed rails: government funding -- either directly or through back-door assumption of debts. They understand that finance is a tool to achieve the public purpose -- whether that is high speed rails or new universities -- and if they've got the real resources then finance should never act as a barrier.

The biggest barrier facing US development is the fear of budget deficits. Hence, all of Obama's statements about the need for deficit reduction, "paying for" spending programs, finding new tax revenues, and debt burdens on our grandkids are dead wrong. That is a topic for a whole blog, so I will wait for a detailed critique.

But it does lead to the ugly we saw on display Tuesday night.

The Ugly. Representative Paul Ryan, without a doubt. I do not mean his physical appearance or his delivery. He's good looking and masterful. Indeed I had to double check my remote to make sure I had not accidentally switched to the Home Shopping Network, with some professional pitchman selling a new miracle cream. He sounded too good to be pitching snake oil economics. But he made the dumbest statement I have heard in years: the greatest concern he has for his children is the future debt burden left by President Obama's profligate spending.

First, as a parent, I can tell you that there are many, many things that are worth worrying about when it comes to your children -- health, school performance, auto accidents, college and careers, love and happiness. Federal government debt? Give me a break -- even if I were a deficit hawk it couldn't make the top 50 of my fears. Sure, I can understand that as an economist or a politician, I do worry about macroeconomic outcomes, economic growth, poverty rates, and so on. But the worries of a parent are entirely different, focused on one's child. If Representative Ryan really was honest in that statement, I fear for his children's welfare.

Second, the federal government debt we leave to our children will be their net financial wealth. I am, literally, leaving some treasuries to my kids -- and I presume Representative Ryan will do the same. Safest wealth we can give them, recognized all over the world as a good store of value. Yes, I know, he made some stupid analogies to Greece -- we do not want to become the "United States of Greece". That only displays that he has no idea what he is talking about. Greece gave up its currency when it joined the euro. All of its solvency problems are related to that mistake. I see no movement in the US to get Americans to give up the dollar. We cannot become Greece. So the government debt we leave them will be part of their financial inheritance.

Finally, and most important of all, we will leave our kids with education, infrastructure, green technologies, higher living standards, better health, and longer lifespans. That is the real inheritance we can choose to leave them with. But only if we stop all this nonsense about debt burdens and the unsustainability of federal budget deficits.

This post originally appeared at Benzinga.

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