[Economic Report of the President (2010)]
[Administration of Barack H. Obama]
[Online through the Government Printing Office, www.gpo.gov]

 
CHAPTER 1


TO RESCUE, REBALANCE,
AND REBUILD


President Obama took office at a time of economic crisis. The recession
that began in December 2007 had accelerated following the financial
crisis in September 2008. By January 2009, 11.9 million people were
unemployed and real gross domestic product (GDP) was falling at a
breakneck pace. The possibility of a second Great Depression was
frighteningly real.

In the first months of the Administration, the President and
Congress took unprecedented actions to restore demand, stabilize
financial markets, and put people back to work. Just 28 days after
his inauguration, the President signed the American Recovery and
Reinvestment Act of 2009, the boldest countercyclical fiscal stimulus
in American history. The Financial Stability Plan, announced in
February, included wide-ranging measures to strengthen the banking
system, increase consumer and business lending, and stem foreclosures
and support the housing market. These and a host of other actions
stabilized the financial system, supported those most directly
affected by the recession, and walked the economy back from the
brink.

But the Administration always knew that stabilizing the economy
would not be enough. The problems that led to the crisis were years
in the making. Continued action will be necessary to return the
economy to full employment. In the process, an important rebalancing
will need to occur. For too many years, America's growth and
prosperity were fed by a boom in consumer spending stemming from
rising asset prices and easy credit. The Federal Government had
likewise been living beyond its means, resulting in large and growing
budget deficits. And our regulatory system had failed to keep up
with financial innovation, allowing risky practices to endanger the
system and the economy. For this reason, the Administration has
sought to help restore the economy to health on a foundation of
greater investment, fiscal responsibility, and a well-functioning
and secure financial system.

Even this important rebalancing would not be sufficient. In addition
to the problems that had set the stage for the crisis, long-term
challenges had been ignored and the U.S. economy was failing at some
of its central tasks. Our health care system was beset by steadily
rising costs, and millions of Americans either had no health insurance
at all or were unsure whether their coverage would be there when they
needed it. Middle-class families had seen their real incomes stagnate
during the previous eight years, while those at the top of the income
distribution had seen their incomes soar. A failure to slow the
consumption of fossil fuels had contributed to global warming and
continued dependence on foreign oil. And a country built on its record
of innovation was failing to invest enough in research and development.

The President has dedicated his Administration to dealing with
these long-run problems as well. As the new decade opens, Congress
has come closer than ever before to passing landmark legislation
reforming the health insurance system. This legislation would make
health insurance more secure for those who have it and affordable for
those who do not, and it would slow the growth rate of health care
costs. Over the past year, the Administration has also worked with
Congress to make important new investments to sustainandimprove K-12
education and community colleges, jump-start the transition to a clean
energy economy, and spur innovation through increased research and
development. These and numerous other initiatives will help to
rebuild the American economy stronger than before and put us on the
path to sustained growth and prosperity. Enacting these policies
will help to ensure that our children and grandchildren inherit a
country as full of promise and as economically secure as ever in our
history.


Rescuing an Economy in Freefall

In December 2007, the American economy entered what at first seemed
likely to be a mild recession. As Figure 1-1 shows, real house prices
(that is, house prices adjusted for inflation) had risen to unprecedented
levels, almost doubling between 1997 and 2006. The rapid run-up in
prices was accompanied by a residential construction boom and
the proliferation of complex mortgages and mortgage-related financial
assets. The fall of national house prices starting in early 2007, and
the associated declines in the values of mortgage-backed and other
related assets, led to a slowdown in the growth of consumer spending,
increases in mortgage defaults and home foreclosures, significant
strains on financial institutions, and reduced credit availability.







By early 2008, the economy was contracting. Employment fell by an
average of 137,000 jobs per month over the first eight months of
2008. Real GDP rose only anemically from the third quarter of 2007
to the second quarter of 2008.

Then in September 2008, the character of the downturn worsened
dramatically. The collapse of Lehman Brothers and the near-collapse
of American International Group (AIG) led to a seizing up of financial
markets and plummeting consumer and business confidence. Parts of the
financial system froze, and assets once assumed to be completely
safe, such as money-market mutual funds, became unstable and subject
to runs. Credit spreads, a common indicator of credit market stress,
spiked to unprecedented levels in the fall of 2008. The value of the
stock market plunged 24 percent in September and October, and another
15 percent by the end of January. As Figure 1-2 shows, over the
final four months of 2008 and the first month of 2009, the economy
lost, on average, a staggering 544,000 jobs per month,the highest
level of job loss since the demobilization at the end of World War
II. Real GDP fell at an increasingly rapid pace: an annual rate of
2.7 percent in the third quarter of 2008, 5.4 percent in the fourth
quarter of 2008, and 6.4 percent in the first quarter of 2009.







Rescuing the Economy from the Great Recession

Thus, the first imperative of the new Administration upon taking
office had to be to turn around an economy in freefall. Chapter 2
describes the unprecedented policy actions the Administration has
taken, together with Congress and the Federal Reserve, to address
the immediate crisis. The large fiscal stimulus in the American Recovery
and Reinvestment Act, the programs to stabilize financial markets and
restart lending, and the policies to assist small businesses and
distressed homeowners have all played a role in generating one of the
sharpest economic turnarounds in post-World War II history. Real GDP
is growing again, job loss has moderated greatly, house prices appear
to have stabilized, and credit spreads have almost returned to normal
levels. A wide range of evidence indicates that in the absence of
the aggressive policy actions, the recession and the attendant
suffering of ordinary Americans would have been far more severe and
could have led to catastrophe.

Yet, because the economy's downward momentum was so great and
the barriers to robust growth from the weakened financial conditions
of households and financial institutions are so strong, the economy
remains distressed and many families continue to struggle. A change
from freefall to growing GDP and moderating job losses is a
dramatic improvement, but it is not nearly enough. Chapter 2
therefore also examines the challenges that remain in achieving a
full recovery. It discusses some possible additional measures to
spur private sector job creation.

Crisis and Recovery in the World Economy

In the early fall of 2008, there was hope that the impact of the
crisis on the rest of the world would be limited. Those hopes were
dashed during the months that followed. In the fourth quarter of 2008
and the first quarter of 2009, real GDP fell sharply--often at
double-digit rates--in the United Kingdom, Germany, Japan, Taiwan,
and elsewhere. The surprisingly rapid spread of the downturn to the
rest of the world reduced the demand for U.S. exports sharply, and
so magnified our economic contraction.

The worldwide crisis required a worldwide response. Chapter 3
describes both the actions taken by individual countries and those
taken through international institutions and cooperation. As described
in the leaders' statement from the September summit of the Group of
Twenty (G-20) nations, the result was ``the largest and most
coordinated fiscal and monetary stimulus ever undertaken''
(Group of Twenty 2009). Just as the actions in the United States
have begun to turn the domestic economy around, these international
actions appear to have put the worst of the global crisis behind us.
But the firmness of the budding recovery varies considerably across
countries, and significant challenges still remain.




Rebalancing the Economy on the
Path to Full Employment

The path from budding recovery to full employment will surely
be a difficult one. The problems that sowed the seeds of the
financial crisis need to be dealt with so that the economy emerges
from the recession with a stronger, more durable prosperity. There
needs to be a rebalancing of the economy away from low personal
saving and large government budget deficits and toward investment.
Our financial system must be strengthened both to provide the lending
needed to support the recovery and to reduce the risk of future crises.


Saving and Investment

The expansion of the 2000s was fueled in part by high consumption.
As Figure 1-3 shows, the share of GDP that takes the form of consumption
has been on a generally upward trend for decades and reached
unprecedented heights in the 2000s. The personal saving rate fell
to exceptionally low levels, and trade deficits were large and persistent.
A substantial amount of the remainder of GDP took the form of housing
construction, which may have crowded out other kinds of investment.
Such an expansion is not just unstable, as we have learned painfully
over the past two years. It also contributes too little to increases
in standards of living. Low investment in equipment and factories
slows the growth of productivity and wages.





Chapter 4 examines the transition from consumption-driven growth
to a greater emphasis on investment and exports. It discusses the
likelihood that consumers will return to saving rates closer to the
postwar average than to the very low rates of the early 2000s. It
also describes the Administration's initiatives to encourage
household saving. Greater personal saving will tend to encourage
investment by helping to maintain low real interest rates. The
increased investment will help to fill some of the gap in demand
left by reduced consumption. Chapter 4 discusses additional
Administration policies, such as investment tax incentives, designed
to promote private investment. Higher saving relative to investment
will reduce net international capital flows to the United States.
Because net foreign borrowing must equal the current account
deficit, lower net capital inflows imply a closer balance of
exports and imports, which will help create further demand for
American products. The Administration also supports aggressive
export promotion measures to further increase demand for our
exports. The end result of this rebalancing will be an economy that
is more stable, more investment-oriented, and more export-oriented,
and thus better for our future standards of living.



Addressing the Long-Run Fiscal Challenge

A key part of the rebalancing that must occur as the economy
returns to full employment and beyond involves taming the Federal
budget deficit. Figure 1-4 shows the actual and projected path of
the budget surplus based on estimates released by the Congressional
Budget Office (CBO) in January 2009, just before President Obama
took office. As the figure makes clear, the budget surpluses of the
late 1990s turned to substantial deficits in the 2000s, and the
deficits were projected to grow even more sharply over the next three
decades. As discussed in Chapter 5, the change to deficits in the
2000s largely reflects policy actions that were not paid for, such
as the 2001 and 2003 tax cuts and the introduction of the Medicare
prescription drug benefit. The projection of steadily increasing
future deficits is largely due to the continuation of the decades-long
trend of rising health care costs.





Chapter 5 describes the likely consequences of these projected
deficits over time and the importance of restoring fiscal discipline.
It also discusses the President's plan for facing this challenge.
A period of severe economic weakness is no time for a large fiscal
contraction. Instead, the Nation must tackle the long-run deficit
problem through actions that address the underlying sources of the
problem over time. The single most important step that can be taken
to reduce future deficits is to adopt health care reform that slows
the growth rate of costs without compromising the quality of care.
In addition, the President's fiscal 2011 budget includes other
significant measures, such as allowing President Bush's tax cuts for
the highest-income earners to expire, reforming international tax
rules to discourage tax avoidance and encourage investment in the
United States, and imposing a three-year freeze in nonsecurity
discretionary spending; alongside a proposal for a bipartisan
commission process to address the long-run gap between revenues
and expenditures.



Building a Safer Financial System

Risky credit practices both encouraged some of the imprudent
rise in consumption and homebuilding in the previous decade and set
the stage for the financial crisis. Chapter 6 analyzes the role that
financial intermediaries play in the economy and diagnoses what went
wrong during the meltdown of financial markets. The crisis showed
that the Nation's financial regulatory structure, much of which had
not been fundamentally changed since the 1930s, failed to keep up with
the evolution of financial markets. The current system provided too
little protection for the economy from actions that could threaten
financial stability and too little protection for ordinary Americans
in their dealings with sophisticated and powerful financial institutions
and other providers of credit. Strengthening our financial system is
thus a key element of the rebalancing needed to assure stable, robust
growth.

Chapter 6 discusses financial regulatory modernization. What is
needed is a system where capital requirements and sensible rules are
set in a way to control excessive risk-taking; where regulators can
consider risks to the system as a whole and not just to individual
institutions; where institutions cannot choose their regulators; where
regulators no longer face the unacceptable choice between the
disorganized, catastrophic failure of a financial institution and a
taxpayer-funded bailout; and where a dedicated agency has consumer
protection as its central mandate. For this reason, the President
put forward a comprehensive plan for financial regulatory reform last
June and is working with Congress to ensure passage of these critical
reforms this year.


Rebuilding a Stronger Economy

Even before the crisis, the economy faced significant long-term
challenges. As a result, it was doing poorly at providing rising
standards of living for the vast majority of Americans. Figure 1-5
shows the evolution of before-tax real median family income since 1960.
Beginning around 1970, slower productivity growth and rising income
inequality caused incomes for most families to grow only slowly.
After a half-decade of higher growth in the 1990s, the real income
of the typical American family actually fell between 2000 and 2006.





A central focus of Administration policy both over the past year and
for the years to come is to build a firmer foundation for the
economy. The President is committed to policies that will raise
living standards for all Americans.


Reforming Health Care

Health care is a key challenge that long predates the current
economic crisis. The existing system has left many Americans who
have health insurance inadequately covered, poorly protected
against insurance industry abuses, and fearful of losing the
insurance they have. And it has left tens of millions of Americans
with no insurance coverage at all. The system also delivers too
little benefit at too high a cost. Comparisons across countries
and, especially, across regions of the United States reveal large
differences in health care spending that are not associated with
differences in health outcomes and that cannot be fully explained
by factors such as differences in demographics, health status,
income, or medical care prices. These large differences in
spending suggest that up to nearly 30 percent of health care
spending could be saved without adverse health consequences. The
unnecessary growth of health care costs is eroding the growth of
take-home pay and is central to our long-run fiscal challenges. These
adverse effects will only become more severe if cost growth is not
slowed.

To illustrate what could happen to workers' earnings in the
absence of reform, Figure 1-6 shows the historical and projected
paths of real total compensation per worker (which includes nonwage
benefits such as health insurance) and total compensation net of
health insurance premiums. As health insurance premiums absorb a
growing fraction of workers' compensation, the remaining portion
of compensation levels off and then starts to decline.





Chapter 7 describes the actions the Administration and Congress
took in 2009 to begin the process of improvement, including an expansion
of the Children's Health Insurance Program to provide access to health
care for millions of children and important investments in the
modernization of the health care system through the Recovery Act.
It also describes the key elements of successful health insurance
reform and discusses the progress that has been made on reform
legislation. Successful reform involves making insurance more secure
for those who have it and expanding coverage to those who lack it.
It must include delivery system reforms, reductions in waste and
improper payments in the Medicare system, and changes in consumer and
firm incentives that will slow the growth rate of costs substantially,
while maintaining and even improving quality. Slowing the growth rate
of health care costs will have benefits throughout the economy: it
will raise standards of living for families, help reduce the Federal
budget deficit relative to what it otherwise would be, benefit state
and local governments, and encourage job growth and improved
macroeconomic performance.


Strengthening the American Labor Force

American workers have suffered greatly in the current recession.
As described in Chapter 8, long-term unemployment is at record
levels. The unemployment rate, which was 10 percent for the country
as a whole in December, is far higher for blacks, Hispanics, and
other demographic groups. The decline in house prices has eroded
the nest eggs that many Americans had been counting on for their
retirement. The Administration has initiated many actions to help
support workers and their families through the recession and beyond.
These actions range from extended and expanded unemployment
insurance, to measures to make health insurance more affordable,
to initiatives to promote retirement saving.
American workers also face the persistent problem of stagnating
incomes. A key determinant of growth in standards of living is the
rate of increase in the education and skills of our workforce. More
and more jobs require education and training beyond the high school
level, along with the ability to complete tasks that are open-ended
and interactive. But, as Figure 1-7 shows, the years of education U.S.
workers have brought to the labor market have risen little in the past
four decades. And, as is well known, U.S. students lag behind those
from many other countries in their performance on standardized tests.

Chapter 8 describes the Administration's initiatives to improve the
skills of our workers. The Administration is pursuing reform to
eliminate wasteful subsidies to student loan providers, the savings
from which will fund new investments in education. The Administration
has proposed a major initiative to support and improve community
colleges, which are a neglected but critical link in our education
system. It has also proposed increasing Pell Grants, and is taking
steps to simplify the student aid application process so that
eligible students are no longer discouraged by a complicated process
from even applying for aid. All of these actions will help to achieve
one of the President's key educational goals for the country--that
the proportion of adults with a college degree be the largest in the
world by 2020.





Transforming the Energy Sector and Addressing Climate Change

Climate change and energy independence present a very different
long-run challenge. Continued reliance on fossil fuels is leading to
the buildup of greenhouse gases in the atmosphere and is changing
our climate. Left unaddressed, these trends will have increasingly
severe consequences over time. What is more, the United States
imports the majority of the oil it uses, much of it from sources
that are potentially subject to disruption.

Chapter 9 analyzes how economic policy can play a critical role
in moving the United States toward a clean energy economy that is
less dependent on fossil fuels and fossil fuel imports. Slowing
climate change requires slowing the emission of greenhouse gases.
A market-based approach, such as that supported by the Administration
and currently working its way through Congress, can provide the
signals needed to accomplish this slowing of emissions efficiently
and with minimal disruptions.

The support for research and development (R&D) and incentives
for investment in clean energy technologies and energy efficiency in
the Recovery Act and the President's budget, as well as in the energy
and climate legislation, can help foster the transition to a clean
energy economy and spur growth in vital new industries. These new
industries have the potential to reinvigorate the American
manufacturing sector and generate secure, high-quality jobs.


Fostering Productivity Growth Through Innovation and Trade

The ultimate driver of growth in average standards of living is
productivity growth. Increased investment in capital and in the
skills of our workforce are two important sources of that growth.
Chapter 10 examines two other sources of productivity gains:
innovation and international trade.

Innovation comes from many sources. But a central one is investment in
R&D. Figure 1-8 shows the share of GDP devoted to R&D over the past
50 years. In the mid-1960s, R&D constituted a larger share of total
spending



than it has in the past decade. And in some other countries, such as
Korea, Sweden, and Japan, R&D spending is a larger fraction of GDP
than in the United States. The President is committed to raising the
share of output devoted to R&D to 3 percent, so that America can
continue to be a leader in new technologies and American workers
and businesses can benefit from more rapid economic growth.
Through the Recovery Act and other measures, the Administration
is investing both directly in basic scientific research and
development and in the infrastructure to support that research.
Most innovation, however, comes from the private sector. Here, the
Administration is providing critical incentives for R&D both in
general and in such vital areas as clean energy technologies. The
Administration is also pursuing a wide range of policies to support
the small businesses that contribute so much to technological
progress--policies ranging from programs to maintain the flow of
credit to small businesses to health insurance reform that will help
level the playing field between small and large businesses.

Finally, international trade can be an important source of
productivity growth and incentives for innovation. Trade has the
potential to allow the U.S. economy to expand output in areas where
it is more productive and to enable higher-productivity firms to
expand. Access to a world market encourages American firms to invest
in the research needed to become technological leaders. Through these
routes, a free and fair trade regime can play an important part in
lifting living standards in the long run. But for trade to play
this role, it is essential to enforce existing trade rules and pursue
policies that ensure that the benefits of trade are widely shared.


Conclusion

The past year has been one of great challenge for all Americans.
Nearly every family has been touched in some way by the fallout from
the crisis in financial markets, the drying up of credit, and the
rise in unemployment. These challenges, moreover, have come after a
decade in which ordinary Americans have seen their living standards
stagnate, their health insurance become less secure, and their
environment deteriorate.
The rest of this Report describes in more detail the actions the
President has taken to end the recession, foster stable growth by
rebalancing production and demand, and rebuild the foundation of the
American economy. More fundamentally, it describes the work that
remains to be done to create the prosperous, dynamic economy the
American people need and deserve.