Mandel on Economics October 16, 2008, 5:00PM EST

How to Get Growth Back on Track

(page 4 of 4)

Browse Issues

Browse the BusinessWeek Archive

Guy Billout

Story Tools

But because they have the option to raise taxes and fees, state and local governments will feel less of a pinch from a slowdown than the private sector will, argues W. Bartley Hildreth, a public finance expert at Wichita State University.

Several things need to happen to get the economy off the slow-growth track. First, the private sector in the U.S. must concentrate on generating more productivity gains at home. In recent years, American multinationals took advantage of globalization to move more and more of their operations abroad. That made sense for the companies, but it created an unsustainable situation in which the U.S. had to keep borrowing from overseas to buy the goods made overseas. That accounted for a big portion of the excess-debt problem.

In addition, U.S. companies need to focus on creating more innovative goods and services that can be produced in this country and shipped abroad. Alas, in recent years the best examples of such exportable "innovations" were new financial instruments such as credit default swaps. The U.S. isn't likely to be exporting that sort of thing anytime soon. What's needed is more breakthroughs in areas such as biotech and energy.

Equally important, policymakers need to think beyond responding to the immediate crisis. Sure, fixing the financial system is essential to prevent demand for goods and services from collapsing, since many consumers and businesses need short-term borrowing to stay afloat. In that sense the solutions to today's crisis echo those of the Great Depression, when factories were idled because of lack of demand.

But unlike the Great Depression, there's a problem on the supply side of the global economy as well—one that requires a different policy response.

In particular, the location and mix of production has to change. Developing countries, with China as the leading example, must build up their ability to supply consumer goods and services to their own populations. "If we do not expand domestic consumption, it is highly likely that gross domestic product growth will be severely limited," says Cao Xuefeng, an economist at China Jianyin Investment Securities in Beijing.

In China, part of that effort requires additional reforms in the service sector, which won't be easy. "The key is for all the innovation, competition, and copying that has taken place in the manufacturing sector to be allowed to break out in services—things like health and education, telecom and finance, law and media," says Stephen Green, head of research for China at Standard Chartered Bank. "If manufacturing slows, only services can provide the employment and productivity you need to grow fast sustainably."

The other half of the equation: When the U.S. government undertakes fiscal stimulus measures, as it inevitably will, the money should be directed toward funding infrastructure, education, and innovation rather than consumer spending. Politically, maintaining a focus on investment and innovation in the U.S. may be almost as difficult as China opening up its service sector to international competition.

In the end, we may look back at fixing the banks as an easy task compared with changing the direction of national economies. As Japan discovered in the 1990s, notes JPMorgan's Kanno, "until the people really feel the pain, it's difficult to implement the radical policies." Let's hope we move more quickly this time.

With Peter Coy in New York, Ian Rowley in Tokyo, Kerry Capell in London, and Chi-Chu Tschang in Beijing

Mandel is chief economist for BusinessWeek.