Will U.S. Policymakers Repeat Mistakes of the 1970s?

A little over 30 years ago, American economic policymakers were
faced with the choice of fighting unemployment or fighting
inflation. Led by the Federal Reserve, which pushed interest rates
to new heights, they opted for the latter and, in the process,
wrecked America's manufacturing sector.

Today, thanks, in part, to the Simpson-Bowles Commission on Deficit
Reduction, which hijacked the conversation about reviving the
economy, policy makers are being asked to make a similar choice;
this time between reducing unemployment and shrinking federal
deficits. Will they learn from past mistakes?

The Fed's approach to fighting inflation in the late 1970s --
sky-high interest rates -- was the worst strategy for the long-term
well being of the U.S. economy. In fact, it exacerbated inflation:
The Fed's governors acknowledged this in minutes of Fed Open Market
Committee meetings.

Ultimately, this led to the recession of the early 1980s, which
briefly pushed unemployment to double-digit levels and put the
burden of the recovery on the backs of workers.

This extreme austerity wasn't necessary. Other countries confronted
with inflation were able to limit the damage to their economies. It
may have taken longer to reduce inflation, but eventually it would
have occurred as the principle causes -- rising oil and food prices
and high interest rates -- receded.

Instead, high interest rates attracted an inflow of money into the
United States. This strengthened the dollar relative to other
currencies, hurting U.S. exports while making imported products less
costly for U.S. consumers. Coupled with policies promoting free
trade, this hobbled manufacturing and caused widespread layoffs
among blue-collar workers.

The U.S. trade deficit today stands at more than three percent of
gross domestic product. Eliminating it would yield significant
economic expansion. However, a strategy focused on deficit
reduction would, once again, mean that workers would pay. This
time, however, the recovery would be weaker because the avenues for
growth are meager.

When U.S. durable goods manufacturing went into decline in the
1980s, capital shifted into other sectors such as finance, housing
and defense, where it could be used more productively. While the
boom on Wall Street produced greater economic inequality, it did
maintain stability until around 2007, when the housing bubble burst
and the finance-based economy showed it could not sustain itself.

Today, education and healthcare are among the few sectors generating
economic growth, but they cannot reduce the trade balance. Only
making more of the things we use and import -- capital goods, autos,
computers, appliances -- can do that.

The United States needs to foster a manufacturing renaissance. The
U.S. still is the world's leading manufacturer, measured by
value. Steel, aluminum, and other primary metal industries employ
three times as many people as those engaged in renewable energy.
These are not your grandfather's steel mills, but modern high-end
companies that operate on the technological frontier. But since
2002, the U.S. has run a deficit in the advanced technology trade.

Industrial leaders such as General Electric CEO Jeff Immelt and
former Intel Chairman Andrew Grove have warned that without
manufacturing, restoring the nation's economic health will be
impossible. Unions have expressed willingness to work with
management to produce mutually shared gains, similar to those
experienced from the end of World War II until the mid 1970s.

To revive America's manufacturing leadership, government may have to
ignore free trade purists, employ "Buy America" provisions, cheaper
currency, target worker training, and levy taxes that encourage
production, not simply increase the dollars going to individuals.
These are the tools that modern states -- most obviously China, but
Germany, France and Japan, too -- use to shape their economies.
Everyone does it but the United States.

It requires presidential leadership. Is Barack Obama up to the
task? Instead of investing in the economy, he chose a stimulus of
tax cuts that will probably increase GDP from 2.4 percent to three
percent next year, but will also be diluted because some portion
will be spent on foreign-made goods. The newest stimulus will not
produce the industrial renaissance, but it will increase the budget
deficit.

Then, President Obama will be confronted with huge political
pressure to put deficit reduction ahead of job creation. America
could wind up with an economy that mirrors New York City: a sliver
of highly-paid professionals at the top and everyone else working at
low-end jobs in the service economy. The program won't revive the
middle class and it won't be sustainable, unless we are willing to
accept eight, nine or even ten percent unemployment as the new
normal.