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Why US voters are suing Dr Obama
By Martin Wolf
Published: October 26 2010 22:28 | Last updated: October 26 2010 22:28
An ambulance stops by the roadside to help a man suffering from a
heart attack. After desperate measures, the patient survives. Brought
into hospital, he then makes a protracted and partial recovery. Then,
two years later, far from feeling grateful, he sues the paramedics and
doctors. If it were not for their interference, he insists, he would
be as good as new. As for the heart attack, it was a minor event. He
would have been far better off if he had been left alone.

That is the situation in which Dr Barack Obama finds himself. A large
part of the American public has long since forgotten the gravity of
the financial heart attack that hit the US in the autumn of 2008. The
Republicans have convinced many voters that the intervention by the
Democrats, not the catastrophe George W.Bush bequeathed, explains the
malaise. It is a propaganda coup.


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Does President Obama deserve blame for this outcome? No and yes. No,
because his treatment was right, in principle; yes, because it was too
cautious, in practice.

It is essential to remember the context. Large financial crises do
long-lasting damage. As the University of Maryland’s Carmen Reinhart
and Harvard University’s Kenneth Rogoff note in an update of previous
work: “More often than not, the aftermath of severe financial crises
shares three characteristics. First, asset market collapses are deep
and prolonged ... Second, [it] is associated with profound declines in
output and employment ... Third, the real value of government debt
tends to explode.” As ever, the risks built up, disregarded, in the
boom and materialised in the bust.

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As Prof Reinhart and Vincent Reinhart of the American Enterprise
Institute note in a paper presented at this year’s economic policy
symposium at Jackson Hole, the US shared with several other high-
income countries (notably, Spain, the UK and Ireland) a massive rise
in house prices, credit and the financial sector’s balance sheet:
between 1997 and 2007, real US house prices rose by 87 per cent, the
ratio of US financial sector debt to gross domestic product rose by 52
per cent and the ratio of total private debt to GDP rose by 101 per
cent. This was a disaster waiting to happen. What has made managing
the bust far more difficult is the fact, demonstrated in the Reinhart
and Reinhart paper, that this has been by far the biggest global
financial crisis since the second world war (see chart).

So how well has the US economy done in this crisis? Quite well, in
some respects, above all on overall economic output; less well, in
others, notably unemployment. On average, real GDP per head (at
purchasing power parity) fell by 9.3 per cent in the previous crises
studied by Profs Reinhart and Rogoff. This time it fell by 5.4 per
cent in the US. The unemployment rate rose by 7 percentage points in
previous crises, on average. This time, US unemployment rose by 5.7
percentage points. (See charts.)


This contrast between poor US performance on unemployment and better
performance on output, by historical standards, carries over to
comparisons between the US and other large high-income countries.
Despite being at the epicentre of the crisis, the US experienced a
smaller proportional decline in output per head than other large high-
income countries, except France. But unemployment rose far faster in
the US than elsewhere. The explanation is that US productivity growth
was exceptionally fast, above all in 2009.

What, then, does this performance tell us about US policy? The answer
is that it did well in terms of what it did address, but far less so
in terms of what it did not address.

As Lawrence Summers, the president’s chief economic adviser, noted at
the FT’s “View from the Top” conference in New York on October 7,
the administration’s focus was on “the return of stability,
confidence and the flow of credit to support strong recovery”. The
elements were: support for the financial system – through the
troubled asset relief programme, inherited from the previous
administration, financial guarantees and “stress tests” on banking
institutions; the fiscal stimulus; and the actions of the Federal
Reserve to sustain the flow of credit.

By their nature, such policies work by sustaining demand and so
output. Their impact on employment (and unemployment) is indirect. As
it turned out, productivity growth was so strong that not too bad a
performance, in terms of output, failed to prevent the surge in
unemployment. One would have expected supporters of the free market to
conclude that the US economy and, particularly, its labour market,
remains flexible, under this “socialist” president. One would have
expected them to conclude, too, that more stimulus was needed. After
all, it was quite modest: fiscal stimulus was less than 6 per cent of
GDP and so accounts for less than a fifth of the cumulative deficits
of 2009, 2010 and 2011, while monetary policy is caught in a liquidity
trap.

The truth is not that policy was foolhardy and failed, but that it was
too timid and so could not succeed. A big mistake was the failure to
address the labour market directly, perhaps by temporarily slashing
payroll taxation. There were other mistakes, too: the effort to reduce
the overhang of household debt should have been stronger.

Yet even the hated Tarp looks remarkably effective in hindsight. As Mr
Summers noted, its cost to the taxpayer looks likely to be ⅓ per cent
of GDP. This is far less than the cost of the bail-out of the savings
and loans institutions in the 1980s. It is also far less than the
direct fiscal cost of comparable crises elsewhere.

Unfortunately, the Republicans have succeeded in persuading a large
enough portion of the American public that if the patient had been
left entirely alone, he would be in perfect health today. This is
surely a fairy story. But voters naturally pay little attention to
calamities averted. They focus only on how far experience falls short
of what they desire. Mr Obama gains no credit for the former and much
blame for the latter. His aspirational rhetoric no doubt worsened the
disappointment.

The president’s willingness to ask for too little was, it turns out,
a huge strategic error. It allows his opponents to argue that the
Democrats had what they wanted, which then failed. If the president
had failed to get what he demanded, he could argue that the outcome
was not his fault. With a political stalemate expected, further action
will now be blocked. A lost decade seems quite likely. That would be a
calamity for the US – and the world.

martin.wolf@ft.com