How to Crank Up America's Economic Dynamo – Financial Times

President Barack Obama said in his State of the Union that the US needs an economy “built to last”. Unfortunately, in his populist rhetoric, Mr Obama missed an opportunity to tee up the conversation the US must have during this election season: How do we restart dynamism in our economy, delivering productivity growth and raising living standards?

The narrative that answers this question has three parts: innovation, investment and inclusion.

Innovation is the ultimate driver of living standards and future jobs. It comes in two forms. First, “non-destructive creation” – the development of entirely new products and business models. Policies that support this include strong federal backing for basic research and financial sector regulation that considers incentives to lend as well as financial stability. Instead, the Dodd-Frank Act will limit the flow of credit to all but the largest and safest borrowers.

“Creative destruction”, the other form of innovation, is also vital. It is important to recognise that net job creation is the difference between job creation and job destruction. In dynamic economies, both creation and destruction are high. In the 20 years before the financial crisis, annual job creation was 17 per cent of employment and annual job destruction was 15 per cent, according to John Haltiwanger of the University of Maryland.

In order to foster creative destruction we need to make it easier to replace failing management and to reallocate labour and capital. Message to Newt Gingrich: job destruction is an important part of economic dynamism. And, yes, private equity firms accelerate that process. Furthermore, low capital gains tax rates make it cheaper to sell assets, thereby helping capital flow more smoothly to its most productive use for the economy.

Investment is the second driver of dynamism. Policies should ensure that both domestic and foreign capital go to productive use. This requires reducing generous subsidies to housing through Fannie Mae and Freddie Mac. We also need tax reform that better allocates resources for investment: reducing marginal tax rates on corporate and individual incomes, broadening the tax base, and cutting back on double taxation of corporate equity returns, which are taxed once at the corporate level and again at the investor level via taxes on dividends and capital gains.

Ways to achieve this include a progressive consumption tax, equalising the tax treatment of debt and equity, and drastically lowering tax rates on dividends and capital gains. All of these ideas have been around in Washington for some time.

We must restrain spending to avoid a high-tax future and to encourage businesses to invest. Mr Obama’s proposal for a so-called “Buffett rule” is less about a minimum tax for high earners than a call for double taxation of returns to investment and risk-taking.

Finally, it is vital that economic policy emphasises broad inclusion in the gains from growth. We should support Americans caught in the change that is a byproduct of our dynamism. Replacing outmoded federal training assistance with personal re-employment accounts should be combined with tax subsidies and education reforms that increase the affordability of community college, technical training and university. Tax and insurance market reforms in healthcare can reduce cost growth and increase take-home pay.

In contrast, Mr Obama has centred his discussion of inclusion on the protection of incumbent firms, as in the General Motors bail-out, misguided financial regulation, and regulation to protect organised labour. This does not promote dynamism, since it speeds up the substitution of technology for jobs.

We have arrived at a fork in the road: growth and recovery or protection and decline. Mr Obama did not even pose the interesting question: How do we achieve an economy built to adapt and grow? Worse, his proposed policies are less consistent with an economy “built to last” than one “last built”.

Read this commentary on The Financial Times.