Zakaria: How to Get Back to Growth

The American economy might surprise us by the year-end. Many economists and businessmen believe that although the current slowdown could turn into a recession, a financial collapse is now highly unlikely. Bruce Kasman, the chief economist at JPMorgan, is an optimist. He believes that even though the economy has been hit by some big problems, it also has strengths that will encourage recovery. (American exports, which now account for most of the country's economic growth, are booming.) But Kasman is a short-term optimist; he has a much gloomier view of the longer term.

For the past 15 years, the U.S. economy has outperformed all other rich countries, averaging real GDP growth of 3.2 percent and monthly job gains of 150,000. This remarkable economic run, which took place as Japan slumped and Europe staggered, has been critical to the country's economic vitality and to the preeminent role Washington has played in the world. Kasman argues—with careful research to back him up—that this period of high productivity and GDP growth has ended. "U.S. growth rates for the next decade or more are going to look more like those in Europe and Japan," he says. Current projections suggest that the long-term growth rate will fall to 2.5 percent at best. If so, that will have huge implications for jobs, incomes and America's general well-being.

Why is this happening? The biggest reason is that there are now fewer workers in the American economy. The baby boomers are beginning to retire, the entry of women into the work force—a phenomenon that boomed in the 1990s—has slowed down and, since 9/11, immigrants, particularly skilled ones, are coming to America at lower rates. In addition, the productivity gains from technology have dwindled; business has gotten the bulk of the benefits of the information revolution.

Capital spending has slowed. Companies are no longer confident that new investments in plants and equipment will produce profits, and despite having large piles of cash, they are not investing much in either. In fact, after the tech boom ended in 2001, capital spending dropped more sharply than at any point since the Great Depression, and still remains abnormally low. Also, money that used to surge into the United States is now going to emerging markets like China, India and Brazil, where the returns on investment are higher. Add to these facts the sky-high prices for oil and commodities, and you have the recipe for a long, 1970s-style slowdown (which may or may not be accompanied by inflation).

The policy debate in Washington is focused on the wrong question: how to spark a short-term, cyclical recovery. Congress has already passed a fiscal stimulus bill, and the Federal Reserve has cut interest rates. All we can do now is wait for these policies to have their effect, which they will. The real debate should be about how to move the American economy back onto a high-growth trajectory. It can be done, but it would require large-scale and smart government policies across a whole range of issues.

The problems are obvious. The retirement of the baby boomers is going to have a crippling effect on all government budgets—federal, state and local. Unless entitlements are trimmed substantially, America is headed for fiscal bankruptcy. Immigration policy needs reform, most urgently so that the United States can once again attract the world's most talented people. Spending on research, technology and infrastructure needs a big boost. (U.S. spending on infrastructure as a percentage of GDP is the lowest in the industrialized world today.) Energy policy needs to be overhauled. Trade policy needs to be revitalized. Tax and regulatory codes need to be simplified in order to keep America a competitive place to do business.

In most of these areas, the solution involves some short-term pain in exchange for long-term gain. But Washington has become incapable of that. Passing a pork-laden bill takes no time. Trimming subsidies, raising taxes or making strategic investments are near impossible.

During the 1980s, the United States tackled many of the problems it faced through bipartisan compromises. The government passed a massive tax reform, with Ronald Reagan and Democrat Dan Rostenkowski championing the bill. It revamped Social Security and passed immigration reform, as well as a series of trade deals—all with strong bipartisan support. These policies were crucial in setting the stage for two decades of strong economic growth. The contrast with today is stark. Now Washington can argue about everything and solve nothing. A can-do country has been saddled with a do-nothing political system.

"With the end of the cold war, we saw a new, destructive kind of partisanship," says David Gergen, who has worked in Republican and Democratic White Houses. "And for much of the past decade, we've kicked the can down the road on our big problems." Some of this is because of the narrowcasting of American politics, a process in which the extreme ends of the spectrum have been magnified and the center gets lost. Part of it, Gergen argues, is generational. "I have a distinct memory that the World War II generation really put country ahead of party. That is simply not the case with the generation in power now."

Compromise is hard. No one gets all or even most of what they want. But in a vast, continental land of 300 million, people are going to disagree. No compromise means nothing will get done. And America will slowly drift down in the roll of nations.