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The short-term versus the long-term

November 2nd, 2009 · No Comments

The goals for the US economy are biting one-another…

President Obama has just laid out a lofty vision for a new economic model for the US, a ‘post-bubble’ model, in which the economy will become less dependent on credit and more on investment and exports. In short, he wants the US to be more like, say Germany (or Japan, or China).

It’s also no stretch of the imagination how to get there:

  • Reduce debt levels and incentivice savings
  • Regulate the financial systems to prevent new credit induced bubbles
  • Invest in R&D, science, infrastructure, education.

Arguably, the US still has one of the best innovation systems around, but this is not without defects. These defects have much to do with the falling educational standards, deteriorating public infrastructure, and a considerable dysfunctional financial system.

Those defects in the US innovation system can be addressed with the proposed policy changes, even if there is no consensus on how to tackle financial reform.

However, a serious problem is that these policies are, at least partly, conflicting with the short-term goals of getting the economy going again. Reigning in the financial system and reparing balance sheets of consumers, businesses and financial institutions is likely to lead to further retrenchment in spending and borrowing, risking the economic recovery.

This is one reason why the Government has to spend, as it can borrow at much lower rates compared to the private sector, and some part of the economy has to keep the spending going to keep the economy from falling into a deflationary-debt spiral while the private sector retrenches and rebuilds balance sheets. 

The US is actually not alone in its disconnect between short-term stimulating and longer-term changes in its required economic model. For instance, China has become even more dependent upon investment to keep it’s economy going (good for 88% of GDP growth in the first six month!).

That is increasing the risk for overcapacity (and associated bad loans) later on. What China needs is to shift more to domestic consumption (actually the exact opposite of the US!). A wage increase or currency appreciation would do the trick.

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