Three ways we can improve the economy in 2014

By Phillip Swagel, AEI

An improving economy and a fiscal truce together signal the possibility of making progress on at least some of the economic challenges facing the United States. Don’t expect a grand bargain with entitlement changes to address the structural fiscal imbalance, or a pro-growth tax reform aimed at putting the U.S. economy back onto a permanently better trajectory. The administration’s policy horizon has shrunk, meaning that these long-term challenges will be left for the next president. But there is still a chance of movement this year on immigration, trade, and housing finance reform, all of which would constitute meaningful progress toward a stronger U.S. economy.

Even with last Friday’s underwhelming jobs report for December, the United States entered the New Year on a roll of good economic news. GDP growth strengthened in the second half of 2013 and looks to stay at 2.5 to 3 percent in the first half of 2014. Indicators for consumer spending, business investment, and international trade all signal a continued expansion, suggesting that job creation will rebound (especially when the subpar December figures include a weather-related construction slowdown and a pause in health care hiring, perhaps reflecting the impact of the botched Obamacare launch). This is not a sizzling recovery, but the pace of growth and job creation in 2014 will be strong enough for Americans to take notice.

At the same time, the Murray-Ryan budget deal and subsequent agreement on spending allocations in the Omnibus bill looks to create two years of (relative) fiscal peace, even while the modest relaxation of the sequester leaves in place considerable spending discipline. Fiscal skirmishes will continue — witness the debate over the extension of long-term unemployment insurance in the Senate. But these battles will not approach the confidence-sapping experience of 2013.

For economic policy, then, the first half of this year is a chance to get something done. Before the Obamacare rollout, the president’s rhetoric suggested that he would eschew a substantive policy agenda in favor of symbolics aimed at taking back the House of Representatives. That now seems unrealistic. This might be bad news for the president politically, but could be good for the nation if it implies more scope for bipartisan policymaking.

President Obama has made clear that his policy focus will be on inequality, with a long list of proposals on this score: a higher minimum wage; promise zones; food stamps; early childhood education; and more. Most are legislative retreads that never came close to enactment, and each has defects. A minimum wage increase, for example, would shave off some jobs that give low-skilled workers their first step up the incomes ladder while delivering only modest help for low-income breadwinners. The promise zone proposal runs crosswise with the economic maxim that policies should focus on improving the lives and opportunities of people rather than places-after all, mobility is a key factor in making the U.S. economy flexible and productive. The Omnibus bill provided an additional $1 billion to support efforts to figure out which early childhood education programs work–a more useful approach than the administration’s proposal for a deluge of money before knowing how to spend it effectively. The inequality proposals provide political talking points but fall short of solutions by which to address the stated problem of inequality (or the more meaningful issue of improving economic opportunity and thus providing upward mobility for all Americans).

The potential economic policy action in 2014 will be elsewhere, namely on trade, immigration, and housing finance reform.

Completion of the Trans-Pacific Partnership (TPP) would strengthen economic growth in the United States and in our allies. Crucially, TPP would involve market-opening reforms in Japan that both help U.S. exports and further Prime Minister Shinzo Abe’s agenda to propel his country out of a decades-long stagnation. This would have security benefits in addition to the economic ones, since a more prosperous Japan would be a more confident partner in standing up to China’s aggressive regional actions. Trade Promotion Authority (TPA) is likely a prerequisite for completing the TPP, since other countries will hesitate to sign on to an agreement that can be amended by Congress. The dilemma is that TPA will go forward only if the White House makes a full-fledged effort to garner support from Congressional allies, but the President is hesitating until he believes that the effort will succeed. TPA looks to be the biggest potential economic accomplishment in Mr. Obama’s second term–he must surely realize that and eventually will make the plunge to push it forward.

The prospects for immigration reform are less certain, but I remain hopeful that an incremental approach can be undertaken in the House that would move in the direction of the bipartisan legislation in the Senate. Reform would improve border security, bring undocumented immigrants into the formal economy, and allow more high-skilled workers to contribute to American innovation and growth. Immigration reform would further help to offset declining labor force participation, a problem that reflects adverse developments in both supply and demand. American workers discouraged by the weak economy (inadequate demand) have stopped looking for jobs, but also demographic movements are leading to lower participation (slowing labor supply). These changes have reduced the unemployment rate as measured, but fewer workers ultimately mean less output and lower incomes. Immigration reform would help reverse this, and represent an infusion on economic and other dimensions, just as previous waves of immigrants have contributed to American society. On the understandable concern about competition for jobs, economic research indicates that low-skilled immigrants first compete with other immigrants rather than with natives.

Finally, reform of the U.S. housing finance system, notably of the two mortgage giants Fannie Mae and Freddie Mac, would safeguard taxpayers from another costly bailout, improve incentives for prudent origination by ensuring that private investors have their own capital at risk, and make mortgage financing more widely available by allowing markets rather than government bureaucrats choose who is financially ready to become a homeowner. Legislative efforts in the Senate would accomplish these goals, with considerable private money at risk ahead of a secondary government guarantee. The 10 percent capital requirement in the Corker-Warner GSE reform proposal would have been far more than enough for Fannie and Freddie to make it through the financial crisis without a costly bailout. The PATH proposal in the House Financial Services Committee also includes a government guarantee on some mortgages through the continued activities of the Federal Housing Administration. The government involvement in the House proposal is narrower, but the difference is of degree, with the underlying goals of taxpayer protection and improved private incentives shared in the proposals. If the two legislative bodies can move forward, a compromise could emerge from a conference committee. As Director of the Federal Housing Finance Agency, former Congressman Mel Watt has considerable discretion to order Fannie and Freddie to take costly actions to support the housing sector. He has already put on hold insurance premium increases that would have better compensated taxpayers for the guarantee they provide to the two firms, and next could instruct them to pour taxpayer money into affordable housing activities. The prospect of such spending could spur action in the House to move forward with a reform that at least circumscribes the government involvement.

Legislative accomplishments in trade, immigration, or housing finance would constitute economic policy progress, even if these fall well short of action on the important issues of fiscal adjustment and tax reform. But it is hard to see progress on latter two areas until after the next presidential inauguration. On fiscal adjustment, congressional Democrats are pushing for the administration to back away from its already modest entitlement reform proposals, and the Obama administration is content with a situation in which the Treasury can fund itself even if the debt ratio hovers around 70 percent. Tax reform appears stuck between differing economic visions across the two political parties. Even on corporate tax reform where there is greater consensus, it will be difficult to bring down tax rates without a base broadening that taps businesses that do not benefit from the lower corporate rate. This then means that more comprehensive reform is needed so that improvements on other dimensions of the tax code can offset the hit to the non-corporate business sector. In the meantime, the Ways and Means Committee is doing excellent work in providing information on the choices involved with tax reform, thereby providing a foundation for future changes even if progress is difficult this year.

Strengthening economic growth this year provides the opportunity to move forward with economic policies, even in an election year. Any legislative accomplishments are difficult in our divided political system. But there are paths forward to be taken.

Phillip Swagel is a scholar at the American Enterprise Institute and a professor at the University of Maryland’s School of Public Policy, where he teaches courses on international economics and is a faculty associate of the Center for Financial Policy at the Robert H. Smith School of Business.  He was Assistant Secretary for Economic Policy at the Treasury Department from December 2006 to January 2009.

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