Interview With Fred Carstensen: U.S. Losing In Global Competition, Underinvesting, Undermining Strengths

Includes: DIA, QQQ, SPY
by: Harlan Levy

Economist Fred Carstensen is a professor of finance and economics at the University of Connecticut and director of UConn's Center for Economic Analysis.

Harlan Levy.: Where is the U.S. economy headed in light of the latest economic reports?

Fred Carstensen: Anemic, very weak growth. The increase in the Social Security tax, raising it 2 percent, is reducing every worker's take-home pay, and that's really the big impact. The increased taxes on high-income households will have negligible impact on economic performance, but the Social Security tax increase, because it's pervasive, will reduce economic growth significantly, and some economic forecasters have cut their forecasts for growth by 1 to 1.5 percent. Some even see just 1 percent growth.

If we proceed with major funding cuts, even as politicians negotiate an agreement for cuts, reduction in federal expenditures will further undermine economic recovery. I think the next two years will have very little job growth and output growth will be cut to 1 to 1.5 percent, significantly lower than what we could have gotten if the public sector hadn't contracted and Social Security taxes had not gone up.

H.L.: Now that we've avoided the fiscal cliff, do you see the remaining political battles threatening the economy, or will there actually be meaningful spending cuts as a result, buoying the economy?

F.C: QE I see the coming fights over the federal budget and sequestration, the automatic dramatic spending cuts in domestic and defense spending, as potentially having only negative consequences for American economic performance.

What people should appreciate is that in all of the arguments and efforts to cut government spending, we are systematically undermining our competitive strengths. Congress is refusing to repair our deeply damaged infrastructure, our highways, airports, and ports. We are systematically underinvesting in basic research, from which critical innovations flow, innovations that drive future economic growth.

We have an immigration policy which is systematically injuring American firms, denying them the ability to hire the skilled workers they need. We are, simply across the board not taking the kinds of steps that we need to maintain and in many cases restore our competitive strengths, while our competitors are making exactly these investments in China, India, Brazil, South Korea, you name it.

The simple fact is that the U.S. is in the process of losing the race in the competitive global contest. It's very important to remember that the real job creators are your readers. If households are unable to buy goods and services, businesses are not going to offer them, they're not going to expand productions, and they're not going to hire the people to provide those goods and services. The true job creators in the world economy are consumers. Insofar as you reduce the capacity of people to consume, which we've done dramatically in the United States, then economic recovery will be a major challenge.

H.L.: Is housing making a real comeback, and if so, is it enough to thrust the economy forward?

F.C.: Housing is actually looking reasonably healthier. It still has a long way to go to return to its historic level, but over the last year and a half housing has made a steady, meaningful improvement. Housing is no longer a significant drag on the economy. The irony is that the housing and construction industry was so severely damaged over the last four years, but now that it is beginning to recover, builders are having a hard time finding qualifies workers, and they're having difficulty finding supplies. Workers left the industry. Lumberyards and other supply channels actually went out of business. So now it is a struggle to resurrect the industry.

But housing is the tail on the dog. The recovery reflects the fact that the private sector has recovered. But the big drag on the American economy has been the consistent contraction in the public sector, and the public sector is still a drag on economic recovery. Housing can't do it on its own.

H.L.: Do you see the labor market doing more than just limping along, adding too few jobs every month to equal new job-seekers, providing a negative drag on housing and the economy?

F.C.: The employment situation nationally we'll continue to see very modest growth, and it will not bring down the unemployment rate, probably for two or three years.

H.L.: How does Connecticut look?

F.C.: Connecticut is in very poor shape. Over the next 30 months the current projections is that state government will make about $2.5 billion in cuts, and on top of that we will probably lose about $2 billion in consumption because of the Social Security tax increase. What's more, because of the state budget cuts, we will lose about $500 million in federal funding.

The result will almost certainly be a very high probability of job losses, and Connecticut may suffer a formal recession, two consecutive quarters of contracting output.

H.L.: The euro zone's massive sovereign debt problems seem less severe these days. Will they just reemerge to plague the global economy?

F.C.: I think that Europe is now managing its fiscal crisis much better. They've taken some of the critical steps to address it successfully, and it will not be a significant drag on the U.S. economy. But Europe will not be the driver in the global economy and will perform quite weakly.

If you were an investor in the European sovereign debt at the bottom, you're a winner. The hedge funds that bet on a recovery have made an awful lot of money.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.