Get ready for a new elite consensus on the U.S. budget deficit. One of the functions of the World Economic Forum – decide for yourself whether this is a virtue or a vice – is to give the plutocrats a venue for figuring out their party line. Think of it as crowd sourcing for the 0.1 per cent.
For a long time, the conventional wisdom among this crew has been that the deficit and the debt were the chief U.S. economic problems. That’s why I wasn’t surprised when Martin Sorrell, head of global communications giant WPP, referred to the deficit as the most important U.S. economic issue at a breakfast panel discussion he moderated at the forum this week. The discussion was off the record, but when I asked Mr. Sorrell if I could quote his comment, he happily doubled down: Not only is the deficit the most important U.S. economic woe, it is the most important global economic challenge.
“This is the world’s grey swan,” Mr. Sorrell told me, a play on the idea of unpredictable, powerful “black swan” events, popularized by financial scholar Nassim Nicholas Taleb.
Most of the panelists (disclosure: I was one of them) agreed with Mr. Sorrell, but this Davos consensus may be on the verge of shifting. One of the most convincing signs of that switch came from an interview I did here with Harvard University economist Lawrence Summers.
Dr. Summers’s is hardly a radical; his résumé includes stints as secretary of the Treasury, president of Harvard, and President Barack Obama’s chief economic adviser. Most importantly, when it comes to the deficit debate, he is a political protégé of Robert Rubin, the Treasury secretary under Bill Clinton who was known for his hawkishness on the deficit.
In short, Dr. Summers is the closest the Davos set comes to a Delphic Oracle and a historic deficit hawk in very good standing. That’s why his relatively dovish comments about U.S. deficit reduction should carry such clout.
His most important point is that economic policy is more like medical treatment than religion. It isn’t a dogma that should be cleaved to under every circumstance. Instead, it is a tool kit, whose particular application depends on the specific patient.
Thus, there is no contradiction between supporting a hawkish approach to U.S. government spending in the 1990s and a more expansionary bias today. The world has changed, so the policy needs to be different, too.
This is how Dr. Summers explains it: “In 1993 … capital costs were really high, the trade deficit was really big, and if you looked at a graph of average wages and the productivity of American workers, those two graphs lay on top of each other. So, bringing down the deficit, reducing capital costs, raising investment, spurring productivity growth, was the right and natural central strategy for spurring growth. That was what Bob Rubin advised Bill Clinton, that was the advice Bill Clinton followed, and they were right.”
But the fact that deficit cutting was the right prescription in the 1990s doesn’t necessarily make it the priority today. “Today, the long-term interest rate is negligible, the constraint on investment is lack of demand, productivity has vastly outstripped wage growth, and the syllogism that reduced deficits spur investments and you’ll get more middle-class wages doesn’t work in the same way,” Dr. Summers said.
True believers in deficit reduction need not give way to complete despair; he insists that deficit reduction is not “inconsequential.” Fail to deal with the deficit in the long run and the inevitable outcome is “economic catastrophe.” The crucial difference, he argued, is that in contrast to the 1990s, deficit reduction “does not constitute the basis for satisfactory growth strategy.”
Instead, to get growth, particularly for the beleaguered middle class, you need what he calls “investment,” a category a budget hawk might simply term “spending.” This conditional view of economic policy is a lovely example of the aphorism that “when the facts change, I change my mind; what do you do?” (It is usually attributed to Keynes, but some pedants say the first recorded version was uttered by Paul Samuelson, the Nobel laureate economist who happened to be an uncle of Dr. Summers.)
It is comfortable to take a religious view of economics: Once you’ve chosen your creed, you never have to think again. But when it comes to deficits – and maybe a lot else besides – that may not be how the world works. Even in Davos, reality trumps ideology.