LAWRENCE H. SUMMERS
The former Treasury Secretary speaks with Irwin Stelzer and Jeffrey Gedmin on China, “decoupling,” reforming capitalism, and the shape of a post-pandemic fiscal policy.
Published on: May 22, 2020
Irwin Stelzer and TAI Editor-in-Chief Jeffrey Gedmin recently spoke with former U.S. Treasury Secretary Lawrence H. Summers in a wide-ranging conversation. They discussed the debate over “decoupling” with China, how to reform capitalism to address legitimate grievances, what an effective response to COVID-19 might look like, and the shape of a post-pandemic U.S. fiscal policy. This transcript has been edited for length and clarity.
Irwin Stelzer & Jeffrey Gedmin for TAI: Let’s start with China, Secretary Summers. There’s a “decoupling” debate emerging now, about whether we should economically disengage from China and diversify our supply chains. If you were advising a new administration, would you keep the tariffs in place? Would you subsidize U.S. production of essential goods? How do you think about this challenge?
Lawrence H. Summers: I think that there’s no more important task for a new President than reconceptualizing the U.S.-China relationship. The strategy of “engagement and hedge” that was conceptualized during the Cold War as a way of gaining leverage against Russia is no longer viable at a time when China and Russia are closer to each other than either is to the United States, when China exists on a very different scale than it did 50 years ago, and when so many of the most pressing security challenges involve cooperating globally rather than balancing powers.
It certainly has not happened that continued economic engagement has led to the convergence of China towards the United States, nor has it led consistently to greater bilateral cooperation. That has to be acknowledged as a starting point. At the same time, there is an American tendency to glom onto prime threats and overreact in ways that can be problematic. The hysteria that prevailed in the United States post-Sputnik was in some ways constructive, but also contributed to fears in Moscow that culminated in the Cuban Missile Crisis and brought the world closer to nuclear war than it has ever been. The Japan hysteria of the late 1980s looks vaguely ridiculous today, but at the time, it was a commonplace within both political parties that the Cold War had ended and Japan had won. Russia was not an economic threat, and Japan was not a security threat. China is potentially both, and so the alarm in the United States is that much greater.
The challenge for a new administration is to harness that alarm constructively to support necessary renewal in the United States, and to assure that our deep security interests are well protected, without succumbing to paranoia that could generate a cycle of hostility between the United States and China, without lapsing into a desire for a degree of U.S. control that’s not plausible given the economic reality, and without putting at risk the capacity to cooperate on the issues that are most important-like pandemic, like climate change, like the risks and opportunities associated with Artificial Intelligence.
We do need to develop our own capacity so that we are much less vulnerable to others in terms of our procurement capacity for key materials. We need the kind of thought that has traditionally gone into export controls and the review of foreign investment to go into the issue of supply chains and U.S. dependence.
In general, economic thinking has privileged efficiency over resilience, and it has been insufficiently concerned with the big downsides of efficiency.In general, economic thinking has privileged efficiency over resilience, and it has been insufficiently concerned with the big downsides of efficiency. Going forward we will need more emphasis on “just in case” even at some cost in terms of “just in time.” More broadly our economic strategy will need to put less emphasis on short-term commercial advantage and pay more attention to long-run strategic advantage.
A great deal of what was in the Trump program was fundamentally irrelevant. Who cares whether China buys soybeans from us or whether Brazil buys soybeans from us? It was rearrangement of trade flows around the bilateral deficit to no particular purpose. Some of the tariffs that were placed on China had the effect of diverting production from China to Vietnam. I think that was to no real purpose.
But I do think that it is incumbent on us to make sure that we have the resilience to not be dependent on China and potential adversaries of the United States for goods that are going to be crucial for us, just as companies do contingency planning around situations where their revenues go to zero for some interval. Now there are many ways to respond. There’s the accumulation of inventories; the kind of thinking that’s behind the Strategic Petroleum Reserve should probably be applied to a much wider range of goods. There are contingency plans to build manufacturing facilities in more flexible ways so that they can be repurposed if need be.
The challenge for the U.S. system will be to implement these policies in a way that is genuinely strategic and in which the national security rationale doesn’t let itself be captured by those whose real motives are protectionism for a particular business interest. The Committee on Foreign Investment in the United States (CFIUS) has done this relatively well, and I think that’s the model that we should be looking to. But there’s no question that the spectacle of the Chinese airlifting masks to the United States should be a spur to much more thought about our own resilience.
Dependence as a concern goes beyond supply chains. We need to assure that we remain central to global standard setting as technologies develop, to assure that our allies are not unduly dependent on China and that there are American companies at the forefront with respect to key technologies. I am no fan of industrial policy generally, but somebody should have done something that assured that there was a serious American competitor in the 5G space.
At the broadest level, we need to craft a relationship with China from the principles of mutual respect and strategic reassurance, with rather less of the feigned affection that there has been in the past. We are not partners. We are not really friends. We are entities that find ourselves on the same small lifeboat in turbulent waters a long way from shore. We need to be pulling in unison if things are to work for either of us. If we can respect each other’s roles, respect our very substantial differences, confine our spheres of negotiation to those areas that are most important for cooperation, and represent the most fundamental interests of our societies, we can have a more successful co-evolution that we have had in recent years.
TAI: You’ve written about the need for “responsible nationalism.” What does that actually mean in terms of economic policies? How do we reform capitalism but preserve it, while making it more popular and sustainable in a democracy?
LHS: Let’s take the global dimension first. We have done too much management of globalization for the benefit of those in Davos, and too little for the benefit of those in Detroit or Dusseldorf.We have done too much management of globalization for the benefit of those in Davos, and too little for the benefit of those in Detroit or Dusseldorf. Over the last two decades, better intellectual property protection for Mickey Mouse and Hollywood movies has been an A level economic issue. Better global tax cooperation, so that tech companies’ profits do not locate themselves in cyberspace and entirely escape taxation, has been a B-level issue. Achieving better market access for derivatives dealers has been an A-level global economic issue, while assuring that bank secrecy does not permit large-scale money laundering has been a B-level economic cooperation issue. The protection of foreign investors’ property rights has been an A-level issue, and the maintenance of worker standards, or the avoidance of unfair competition through exchange rate depreciation, has been a B-level issue. And ultimately, that has all estranged the elite from those they aspire to lead.
Someone put it to me this way: First, we said that you are going to lose your job, but it was okay because when you got your new one, you were going to have higher wages thanks to lower prices because of international trade. Then we said that your company was going to move your job overseas, but it was really necessary because if we didn’t do that, then your company was going to be less competitive. Now we’re saying that we have to cut the taxes on those companies and cut the calculus class from your kid’s high school, because otherwise we won’t be able to attract companies to the United States, and you have to pay higher taxes and live with fewer services. At a certain point, people say, “This whole global thing doesn’t work for me,” and they have a point.
So we need a global agenda that is about broad popular interests rather than about corporate freedom-that is, cooperation to assure that government purposes can be served and that global threats can be met. If we have an agenda like that, we can rebuild a constituency for global dialogue.
More broadly, we need a reconsideration of what economists would call the role of high-powered incentives. The profit motive is a very positive thing. It drives businesses to be more efficient. It drives businesses to create new product. It drives economies forward. But profit can also be an incentive to the exploitation of workers. It can be an incentive to the exploitation of consumers.
In a world where firms compete too ruthlessly for market share, if somebody cuts a corner, there can be overwhelming pressure for everyone to cut that corner in order to survive-whether it is maintaining insufficient capital in a financial institution, using a deceptive marketing practice that addicts customers, or producing in a way that is invisibly unsafe. So the case for regulation is not to be anti-business. Regulation needs to be supported because it enables the vast majority of businesses who want to do right by society to do so and still be able to compete. That’s how the case for regulation needs to be framed. We should not be waging jihad against business. We should be waging jihad against those who put profit ahead of every other value in the society.We should not be waging jihad against business. We should be waging jihad against those who put profit ahead of every other value in the society. And that’s where in the emphasis on profit, we have gone a bit awry.
TAI: Would you carry that to the point of having government representatives on corporate boards, for example? How deep into the profit system would you insert the government?
LHS: I think the evidence on government membership on boards is not very encouraging. I’m much more comfortable with governments making rules, establishing minimum wages, establishing minimum safety standards, establishing capital and credential requirements for banks, and then letting those institutions optimize as they see fit. The great problem with overly enfranchising governments or workers on boards is that the interests they represent tend to be those of the status quo and the past. When shoe businesses left New England to go to the South in the 1950s, it created new opportunities and made America a more equal country. If status quo interests had been represented on those boards, they would have stood for keeping those businesses in New England.
It’s a very difficult set of balances to strike. My own instincts are in favor of government establishing the superstructure, in terms of a more progressive tax system that permits more social insurance and more fairness, and through rules that internalize adverse externalities, rather than taking stakes directly in enterprises. But I think we will see some experimentation in the time ahead, and that is a valuable thing.
TAI: Let’s move to the area of debt and deficits. Say you were back at the Treasury, and the pandemic is over. We’d been running deficits of 20 percent of GDP. Interest rates are zero, maybe even less in real terms. What would you do if you inherited the balance sheet and the income statement of the U.S. government and were told to fix it?
LHS: The deepest truth about debt is that you can’t evaluate borrowing without knowing what it’s going to be used for. Borrowing to invest in ways that earn a higher return than the cost of borrowing, and provide the wherewithal for debt service with an excess leftover, is generally a good and sustainable thing. Borrowing to finance consumption, leaving no return to cover debt service, is generally an unsustainable and problematic thing. So I think we need to move beyond the tendency to speak in terms of thresholds of debt. We also need to recognize that as important as it is to look at debt ratios, it’s also important to look at debt-service ratios. Japan, for example, which has a very high debt ratio, has a very low debt-service ratio and has for many years now experienced no substantial upwards market pressure on interest rates.
I think we need to be very careful, with respect to the expectation that we now seem to be setting of having government cover all the losses associated with the COVID period. For the life of me, I cannot understand why grants should have been made to airlines to enable them to continue to function, rather than allowing their share values to be further depressed, and allowing those who would earn substantial premiums by taking risk on airline bonds to do so, accepting the consequences of an investment gone wrong.
Looking towards an economy that is going to be very different than the one we had before COVID, we cannot aspire to maintain every job or every enterprise with a compensation program indefinitely. So as I look at the 30 percent of GDP deficit that we are running in Quarters Three and Four of Fiscal 2020, I don’t think that can be sustained over a multi-year period. At the same time, I think the Simpson-Bowles mentality, in retrospect-and I had this suspicion at the time, when I started talking about secular stagnation-was largely misplaced. We have an economy where there’s a very strong propensity to save, in part because of redistribution towards those with high incomes, in part because of uncertainty and demographic developments, and where because of what I call a broad “demassification” of the economy, there’s a much lower propensity to invest than was previously the case. That’s an economy that’s going to be fundamentally sluggish and prone to low interest rates.
In that context, we need to think about the public sector taking a much larger role in assuring the adequacy of demand and assuring that excess savings not slosh into bidding assets up to ludicrous prices and creating the conditions for financial instability. My advice to policymakers would be to focus maximum energy on public investment and the assurance of reduced uncertainty for individuals and businesses. That’s an agenda that will involve larger taxation, and substantial renewal of both our traditional infrastructure and the infrastructure that’s necessary for a green information economy, rather than a brown industrial economy.
Those should be our primary objectives, not hitting particular benchmarks on debt. We should think of a moment when we can borrow for 30 years at an interest rate of 1.3 or 1.4 percent in a currency that we print ourselves as a remarkable opportunity, and it should be our business to take advantage of that opportunity to renew and reconstruct our society.
TAI: When you talk about higher taxation, could you give us a broad outline of the direction you have in mind? What’s the burden of taxation that would optimize future growth?
LHS: The single easiest answer is that we could raise well over a trillion dollars over the next decade by simply enforcing the tax law that we have against people with high incomes. Natasha Sarin and I made this case and generated a revenue estimate some time ago. If we just restored the IRS to its previous size, judged relatively to the economy; if we moved past the massive injustice represented by the fact that you’re more likely to get audited if you receive the earned income tax credit (EITC) than if you earn $300,000 a year or more; if we made plausible use of information technology and the IRS got to where the credit card companies were 20 years ago, in terms of information technology-matching; and if we required of those who make shelter investments the kind of regular reporting that we require of cleaning women, we would raise, by my estimate, over a trillion dollars. Former IRS Commissioner Charles Rossotti, who knows more about it than I do, thinks the figure is closer to $2 trillion. That’s where we should start.
Over time I think we are going to need a larger public sector in the United States to deal with the challenges of a more complex world: an aging society, more inequality that requires mitigation, and a huge change in the relative price of the things the public sector buys, like healthcare and education. We’re going to need more revenue, beyond the unsustainable borrowing that we’re engaged in now. But the first way to get it is enforcing the law we have, which will raise substantial revenue progressively and in ways that will actually promote economic efficiency.
The second way to get it is by closing a range of tax benefits that distort the allocation of resources and that encourage production and economic activities to take place outside the United States. Included in those would be the closing of loopholes in the capital gains tax, a stepped-up basis at death, and raising the rate on capital gains taxes. There is no reason at all why an individual who earns capital gains should be able to entirely avoid tax on those capital gains by passing them on to his children. Taxing capital gains at death and raising the capital gains tax rate in a way that assured parity would raise hundreds of billions of dollars.
TAI: Would you eliminate it altogether and treat capital gains as income?
LHS: As long as we’re in a low inflation environment, yes, I would, but only if you also did stepped-up basis at death, so you didn’t just encourage capital gains assets to be held indefinitely. In that case, you wouldn’t raise any revenue. I would also correct a variety of corporate shelter provisions and especially the breaks that were provided to master limited partnerships and the like in the most recent 2017 tax legislation. The third area I would look at is green taxes, and in particular, some substantial taxation of carbon, which would increase economic efficiency.
TAI: What about a wealth tax, this idea that’s been popularized by Thomas Piketty and Elizabeth Warren?
LHS: Well, my principle would be that I see a need to raise revenue, and I want to do it in the least burdensome way possible. That means taxing those who could most support to pay proportionately and levying taxes in a way that makes the economy more, rather than less, efficient. That is a different philosophy than the philosophy of most wealth tax advocates who, quite apart from any revenue that’s raised, see the destruction of wealth as a positive thing. I do not share that view.
It seems to me that the wealth tax, as I’ve written elsewhere, has a variety of administrative problems, and that it poses most of the same issues that the estate tax does, in terms of loopholes. And I think that America would be better off if there were more people like Bill Gates and Jeff Bezos, not fewer.I think that America would be better off if there were more people like Bill Gates and Jeff Bezos, not fewer. So taxation on the basis of ability to pay, yes; taxation for the sole objective of tearing the rich down, no, that would not be my approach.
TAI: You favor raising the minimum wage. Is that because such a step would lower inequality? And
what are your thoughts about universal basic income?
LHS: I do support raising the minimum wage. It’s a matter of balance. I don’t think the minimum wage was doing any significant damage in terms of causing unemployment when Ronald Reagan was president, and the federal minimum wage is now substantially lower, after adjusting for inflation, than it was at that time. I believe raising the minimum wage would help a lot of people who are in substantial need.
I’m not enthusiastic about a universal basic income because the fact that it is so poorly targeted, precisely because of its universality, mean that it will either be prohibitively expensively or will not provide adequate benefits to the poor. Imagine a universal basic income could pay $10,000 per person-that would require nearly a doubling in the federal budget, or more than a doubling in federal tax collection, in order to finance it. That doesn’t seem to me to be remotely tenable. If you make it inexpensive, then you’re not going to be doing very much to help poor people.
I also think that contrary to economic theory, which supposes that leisure is good and work is bad, that many people derive satisfaction from work and from being a contributing part of the community. The idea that a fortunate minority of the economy should buy the peace from a majority that doesn’t work seems to me the basis for a very unhealthy society.The idea that a fortunate minority of the economy should buy the peace from a majority that doesn’t work seems to me the basis for a very unhealthy society.
TAI: At least on that one point, then, you disagree with Keynes.
LHS: There’s a lot of empirical evidence since Keynes wrote, and for every non-employed middle-aged man who’s learning to play the harp or to appreciate the Impressionists, there are a hundred who are drinking beer, playing video games, and watching 10 hours of TV a day.
TAI: Considering our current crisis, how do you think about the question of reopening the economy? What metrics do you look at for costs and benefits?
LHS: It’s still early days, but remarkably, the data suggest that lockdowns are much less consequential for either health or the economy than people might suppose. Think about it. Would I change my life very much if lockdowns were removed? I still wouldn’t go to crowded restaurants. I still wouldn’t go see the Red Sox. I still would be inclined to shop on Amazon rather than in my local bookstore. What is striking in the data that my colleague Raj Chetty has generated is that the change in consumer expenditure over the last several weeks in Georgia and New York has been very similar. States that open up do not seem to have much greater increases in expenditures, nor do they need to have much greater increases in coronavirus case rates.
So it appears that everything we see has more to do with self-defense from the virus than it does with legal mandate. A similar conclusion comes out of Sweden and Denmark. The decline in spending has been about 80 percent as great in Sweden as it has been in Denmark, despite the complete absence of distancing measures in Sweden.
In general, one’s best off tracking relatively objective health indicators that are not a function of the measurement process. I don’t pay much attention to the daily information on case rates, which speak to how many tests we’re doing and how well targeted those tests are. I’m much more interested in the daily data on hospitalizations, the number of people going into intensive care, and the number of people who die.
My decision-making will be based on those variables, because I think it’s pretty clear that if they are not under control, there’s no chance that you’re going to have a viable economy, whether you change lockdown procedures or not. And if we are able to bring the health situation under control, I think it’s clear that we’re likely to see increases in expenditure and employment. Still, it’s necessary to be very careful because if we know one thing about serious epidemics, it’s that they come in multiple waves.
TAI: But what about the effect on 40 million unemployed people across the country? The guy who delivers your pizza, say?
LHS: I think it’s the pizza guy who’s most likely to suffer from the second wave. Again, the evidence is really quite surprising, but it’s less the lockdown policies than the judgment about what’s safe or not safe that is driving the economy. There’s a variety of data on this. You could look at the mobility data from Apple or Google, for instance, or data on miles driven during the crisis.
The real crime is not that we miscalibrated on some economic versus public health trade-off. The real crime is that we have not succeeded in generating far greater quantities of testingThe real crime is not that we miscalibrated on some economic versus public health trade-off. The real crime is that we have not succeeded in generating far greater quantities of testing, far greater mechanisms for those 40 million unemployed people to do contract tracing, far more availability of well-fitting, comfortable, and safe masks, and that we’re under-investing in the development of new therapeutics and vaccines.
When something costs $10 to $15 billion a day, you need to make decisions in new ways. We should not be waiting to see which of two tests works best. We should be producing both of them. We should not wait for vaccines to be proven before we start producing them. We should be producing all the plausible candidates. Remember, one week earlier in moving through this is worth a hundred billion dollars: two months’ worth of the annual defense budget.
TAI: Speaking of government competence, there seems in general to be in government a gap between good ideas and their implementation. Can you think of any institutional fixes for that, in terms of how our government is organized?
LHS: I certainly have no silver-bullet solutions for how government can become more competent. It seems to me, though, that over the years we have made civil service a considerably less attractive career route for able young people. We have allowed the relative pay of civil servants to decline quite substantially compared to the pay of young people who go into business. Even more consequentially, there has been a steady trend towards growth in the number of political appointees. Entirely apart from any question about the competence of political appointees, or their possibly greater responsiveness to elected leaders, there’s surely going to be a loss in the quality of career officials when the top 20 positions in the Treasury Department are all closed to them.
If there were more ambassadorships for foreign service officers and fewer for campaign supporters, more able people would choose to go into the foreign service. In general, government has the problem that it is managed by non-institutional short-term players with short horizons. A senior manager who has worked at Procter & Gamble for 25 years is going to be very invested in developing the people of Procter & Gamble, while an Assistant Secretary in an administration expected to stay in their position for 18 months is neither going to be acculturated nor motivated to investing in the career development of civil servants.
As in many areas of life, you have what I call the parable of the generators. In many developing countries, it’s difficult to provide steady and reliable electricity. What happens then is people get their own generator. When the elite all have their own generators, the incentive to invest in better public generators is attenuated. This is what Albert Hirschman wrote about in his classic Exit, Voice, and Loyalty.
And as the civil service gets worse, the tendency to workarounds of various kinds-partnership with the private sector, or bringing in a special, elite corps of civil servants-is increased, and that contributes to the deterioration of the civil service. So I would start with the questions of improving career paths. And that requires a leadership that values the civil service and treats government with respect. When we have a President of the United States who thinks the government he leads is the enemy, it’s hardly surprising that people who want to serve the public don’t choose to go work in government.
TAI: Finally, Secretary Summers, what are you reading, listening to, or watching in times like these?
LHS: I have to say that I am spending more time working and reading documents on public policy than at any time since I was in government, just trying to keep up with all that is happening. When I’m not doing that, it has been fairly escapist. I have made my way through The Last Dance, the new Michael Jordan documentary. I’ve watched several seasons’ worth of Homeland.
In recognition of the fact that my daughter is about to begin a medical residency, I have read The House of God, Samuel Shem’s classic MASH-like depiction of life in a major academic hospital. I have also been reading about F.D.R. and his leadership during the Depression and World War II, because they both seem connected to our current difficulties.