by Peter Boone, Effective Intervention
and Simon Johnson, Peterson Institute for International Economics
and James Kwak, Yale Law School
Post on the Wall Street Journal's Real Time Economics
November 11, 2008
© Wall Street Journal
The Bush administration has been hard at work supporting the US credit system over the past two months—admittedly, after first causing the greatest crisis of confidence in the history of modern financial systems. The Fed has taken on obligations, explicit or implicit, amounting to over 70 percent of GDP. The Treasury has switched away from creating a massive securities trading house toward injections of capital into a widening range of financial institutions.
But there is no strategy here, just a series of innovative (from the Fed) and belated (from the Treasury) improvisations. Mr. Obama’s administration will first be preoccupied with an economic stimulus package and a program to stabilize the housing market. But very soon it will need a new strategy, based on recognition of three new realities:
This situation, while unfortunate in the aggregate and a tragedy for many vulnerable individuals, actually presents a major opportunity for the United States.
The opportunity is to transform the economy by moving resources (capital and people) out of financial services and into manufacturing, technology, and other activities based on "real" (i.e., nonfinancial) innovation. This switch plays to a number of strengths in the United States: people (and capital) move relatively easily compared to other countries; we have great depth in the development of technology (our engineering schools lead the world); we are very good at creating new companies (many have tried to replicate Silicon Valley, few have even come close); and, if managed well, we will continue to have the deepest and most flexible capital markets in the world.
American companies are also extremely imaginative and make rapid, decentralized decisions when faced with sensible market incentives. All we know today is that the successful companies of the future will be based on new or newly adapted technology. The private sector will figure out the rest—ideally, guided by sensible regulation from the public sector.
The strategy for Mr. Obama is simple. His administration needs to recognize and facilitate this sea change in the allocation of resources, instead of making the mistake of trying to protect the status quo. Specifically, this means:
Our best chance is a strong, self-assured United States, with a sustainable, high rate of growth, leading the world through example and innovation. It all lies within Mr. Obama's grasp.
Simon Johnson is a senior fellow at the Peterson Institute for International Economics and a professor at MIT. He is a cofounder of the blog Baseline Scenario (http://baselinescenario.com).
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