The US economy is not dead, but it's not about to run a triathlon any time soon. We're in intensive care in a third rate hospital in the hands of a medical team struggling to come up with a convincing diagnosis. The good news is that the patient is resilient and the knowledge we gain from experimental cures will help us save future patients.
There are two problems. The first is the hangover from a binge lending episode that ended badly in 2008. That episode was caused by a bout of optimistic expansion in which half the world lent to the other half. Everyone knew the asset price boom would end. But the gains made during the upswing were too big to ignore. And when it came: the landing was hard. The borrowers are still paying down their accumulated debts.
The problem with the capital markets is not, as some would claim, that people are irrational. During the debt crisis, we were all acting in our own best interest. And we knew it. People are rational. Markets are not. The world economy is recovering from a nasty bout of idiopathic rational exuberance.
The 2008 debt crisis taught us that financial markets sometimes screw up in a major way. In my forthcoming book, “Prosperity for All: How to Prevent Financial Crises”, I explain what went wrong and how to fix it. We must create an institutional mechanism to stabilize swings in the financial markets that always, eventually, end badly.
The second problem is chronic. Doctors swear to “do no harm”. Economists swear to “block no trade”. That's been a healthy doctrine for most people in the world: if you don’t believe me, just ask the 1.5 billion Chinese workers who saw growth rates of more than 10 percent a year for decades. And it's been a healthy doctrine for the wealthy and educated elites in the US whose income is derived from owning physical or human capital. But 1.5 billion Chinese workers do not vote in US elections. And American workers have not fared so well.
The second problem for western democracies is to find a way to redistribute the gains from global trade to working class and middle class voters who have seen their living standards eroded at the expense of Chinese workers and the educated western elites who control the debate.