The beginning of a new year is a time to make resolutions. It is also a good time to set out one’s wishes – regardless of whether they can be actually achieved during the following months. In that spirit, here are my top wishes for the U.S. and global economy during 2011. Achievement of even a few of them would help bring about sustainable economic growth as well as reduce the level of risk in the financial system.

• Employment Generation
  Continuing to face near 10% unemployment in the United States, the Obama administration should finally make job creation and retraining its principal and overwhelming priority. Rather than implement health care reform or pollution control, top officials will deal with the newly Republican controlled House of Representatives in putting every economic issue through the prism of employment generation. The potential of a measure to create sustainable employment would make it a priority, whereas steps that may detract from that objective will push it to the back-burner.

 

• Link Subsidies to Job Retention Rather Than Unemployment Compensation
  In line with the newly announced focus on job creation, the U.S. will increasingly shift subsidies to employers to retain workers at a reduced pay, and incentivize workers to retrain themselves. As I have written in the past year, the German program of “kurzarbeit” (short-time work) does precisely this, helping gain back all the jobs lost during the recession of 2007-2008. As part of my wish, the Obama administration will find funds for this purpose by using the job retention program to replace the recently announced 13-month extension for unemployment compensation. With almost one-half of the unemployed having been jobless for six months or longer, worker retraining takes on particular importance in dealing with unemployment which is becoming structural and chronic.

 

• Rationalization of Tax Code Should Follow Extension of Tax Cuts
  President Obama upset many of his Democratic supporters, and pleasantly surprised the Republican opposition, by agreeing to extend the Bush tax cuts for two more years for all taxpayers. This is a positive step in reducing uncertainty for consumers and investors, but will count as a meaningful structural adjustment only if it is followed by a rationalization of the tax code during 2011. A lower overall income tax rate would be compatible with reducing the fiscal deficit if all deduction loopholes – yes, all of them – are closed. This would include the much cherished deductions for mortgage interest payments and charitable contributions. To allow some loopholes to persist would only encourage special interest groups to seek to protect their turf, and delay the tax rationalization process.

 

• Spending Discipline Needs to Accompany Tax Code Changes
  With public debt approaching 100% of GDP of about $14 trillion –compared with a 50% figure generally believed to be a “safe” maximum –the U.S. faces an urgent need to slow spending and lower the debt / GDP ratio to more manageable levels. Although President Obama settled the budget battle last month in agreeing to the extension of the tax cut, winning the budget war requires an explicit exit strategy from the estimated $1.4 trillion in annual fiscal shortfalls. “Sacred cows” have to be dealt with on the spending side. Will authorities tell workers they have to work longer before they can receive Social Security benefit payments? A meaningful increase in the age of entitlement, say, from 65 to 70 years, would go a long way to lower the deficit, and be consistent with the generally improving health of the American population.

 

• Confront the Deteriorating State and Local Finances
  The deterioration in municipal finances since the global financial crisis has not produced any suggestions from the Obama administration on how to deal with it. The U.S. municipal bond market is large at about $2.8 trillion, and several state obligations have been downgraded by rating agencies. Unrealistic return expectations on assets held by the public pension funds, and persistent increases in wage and pension obligations, have been the principal factors behind worsening situation. Rather than let the situation worsen before taking action, it is essential that steps to restructure debt payments and public sector expenditures occur in anticipation of it.

 

• Free Trade Agreements: Colombia and Panama Are Waiting
  In his State of the Union message last year, President Obama targeted a doubling of exports in five years to speed up U.S. economic growth and create jobs. With the Korean deal approved toward the end of last year, Colombia, South America’s largest market for U.S. farm products, and Panama, with its historical ties with the U.S., are still waiting. Despite opposition from U.S. labor groups, the President needs to achieve both trade agreements this year.

 

• Overhaul Fannie Mae and Freddie Mac
  Devastated by the fall in home prices, the organizations were put under the receivership of the Federal Housing Finance Agency in September 2008. Even though the two entities owned or guaranteed 57% of the $12 trillion mortgage market that year, they were left out of the Dodd-Frank Wall Street Reform Act that was passed in 2010. The Republican leadership, which had criticized Fannie’s and Freddie’s omission, is now reluctant to restructure them – including a privatization of the entities – due to concern that it may cause the housing market to worsen again. For housing to have a durable recovery, it is essential that the government reduce support, even if gradually, and let the private market fill the role.

 

 

Some 2011 Wishes for Foreign Economies

 

• European Union: Speed Up the Debt Reduction Process
  The festive period toward the end of 2010 provided a respite from further bad news from southern Europe. However, that may be deceptive. Ireland seems set for elections early in the year, with the incoming government unlikely to continue the austerity measures agreed to by the outgoing cabinet. That, and the persistence of high yields on Greek, Irish, Portuguese and Spanish debt suggests that these countries will look for additional bailouts from official EU entities. EU economic prospects would be substantially enhanced if they restructure debt to levels that the countries can safely service as well as enjoy healthy economic growth.

 

• Strengthen the Euro: Coordinate Fiscal Policies
  Even with debt reduction, the Eurozone cannot survive in its present form if some countries resume their borrowing binge. To remain a member of the single-currency area, it is important that the 17-country bloc impose restrictions on fiscal deficits and on external borrowings. Without such restrictions, the Eurozone runs the risk of encountering periodic crises as some countries accumulate excessive debt expecting to be bailed out by the other member countries.

 

• China and India: Open Up to Increased Foreign Competition
  Even though the two countries are in the process of becoming major global economic powers, inflow of foreign investment is heavily regulated, and their currencies are not fully convertible on the capital account of the balance of payments. Limited currency convertibility is especially a problem in China and causes an excessive accumulation of foreign exchange with the central bank, worsening the inflation problem. A move toward greater convertibility for the renminbi and the rupee would also enable them to be used more in international transactions and, eventually, provide credible alternatives to the U.S. dollar.

 

• Last Wish: Global Policy Coordination
  What began as a U.S. subprime problem in 2008 quickly transmuted into an international banking and sovereign debt crisis. Yet, the corrective measures adopted so far –in the United States, the United Kingdom and the Eurozone –have been arrived at based mostly on domestic considerations, with the international implications an afterthought, if at all. For example, the Dodd-Frank Act for financial reform was concluded based on measures that could obtain sufficient votes in the U.S. Congress. To begin with, I would like to see at least the major North American and European governments arriving at common goals and restrictions pertaining to risk-taking in order to reduce the likelihood of a future contagion.

 

 

 Komal S. Sri-Kumar

 Chief Global Strategist

 

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www.tcw.com