they had no say in that process. it was a stolen election. down here in virginia, fortunately the farmers did have some representation. they had already fought for that in the early days of the legislature. but james madison made a deal with the modern antifederalists to switch sides at the last minute. he promised he would push for a bill of rights if he won election, in the first congress. and he did, and there were something like 70 or 80 proposals for guarantees of individual rights, and he boiled them down to 12. 10 of which were approved by the states. by the tenth 10th amendment which is supposedly was a sop to states, to protection of state rights did not protect state

sovereignty, and within a few years john marshall and the supreme court stripped the states, of what little sovereignty they had left and eventually the civil war did the rest of it. .. >> he wrote a letter to the -- i think it was to washington. i've forgotten. he wrote a famous letter that if he was in america, he would approve -- encourage 9 of the states to approve the constitution and four of them to refuse until a passage of a bill

of rights. so he was neither for nor against. he flip flopped. [laughter] >> for more on author har low unger and his work, visit harlowunger.com. >> glenn hubbard a former economic advisor to president george bush argue president obama's push for higher taxes and more regulation is exactly the wrong thing to do to improve the economy. the event hosted by the american enterprise institute in washington, d.c. is 90 minutes. >> good morning, everybody. i'm arthur brooks president of the american institute. and it's how to have american

prosperity and it's glenn hubbard and a distinguished panel. the three enterprise movement or the culture of free enterprise has been under relatively sustained attack for some time. most people would agree and the proponents of free enterprise have taken on the challenge of this over the past couple of years with great vigor. the free enterprise movement have made remarkable gains in making the principled gains. to win the future, free enterprise advocates need to have a full set of policies, however. they need to say what we need to do as opposed to what we need to stop doing. we need to address the threats, the realistic threats in a fair and honest way facing our nation. and set america free as a nation of entrepreneurs. but we have to find a practical way to this. well, glenn hubbard who was our featured speaker today and his co-author, peter navarro have the policy sets for america and

they detail them in a brand-new book that some of you have seen entitled seeds of destruction why the of economic destruction leads to through and leads to public prosperity. glenn hubbard is not a strange savior aei audiences. he's the former chairman of the council of economic advisors to the president. he's a prolific author and speaker. public intellectual and he's a member of aei's council of economic advisors. he's here quite a lot and we're delighted of that. he's joined today after a presentation of his new work by a panel that you see before you here today that features ramesh from the national review, carmon reinhart from the university of maryland and the panel will be moderated by our very own head of economic policy studies, kevin hassett. so please join me in welcoming

glenn hubbard. [applause] >> thanks very much, arthur, for that kind introduction. and thanks to a hail and hearty audience showing up after thanksgiving. the books "seeds of destruction" that i wrote of peter navarro is a classmate of mine in graduate school, is a wonderful christmas present so let me just promote it right here. it will make great stocking stuffers. when peter and i sat down to write this book it was about a search for both ideas and common ground. peter is a democrat. i am not. and what we did was to try to search for ideas that were both intellectually important to the two of us but also had a chance of happening. the first interview i gave when i worked at the treasury department in the early 1990s was to david wessle who the the

tax beat for the "wall street journal." and he asked me about the time frame for completion of the corporate tax integration study that the treasury was then doing and i had been handed the economic stewardship of. and i said, you know, i think this interview is 1991. i said in this it will be ready when my son goes to college. the "wall street journal" reported that interview and noted that my son was mine months old and my son is in college and we're debating at least to extend dividend cuts and policy is moving faster than i thought. we thought policy was more than just waiting for a generation. now, in setting the stage of the book, i'll just make a couple of observations and then maybe a moment about what the book is about. the first observation is that amity chalets is right.

she was very kind to write the forward to the book. and she began with an observation that the 1950s are very interesting. republicans want to live there, democrats want to work there. and i think what amity meant by that observation in a sense she was right is that the 1950s in popular imagination are a kind of a halcyon time for many conservatives. there's the memory of better growth for much of that decade. for all of us, i think at last memory of the shared prosperity of that growth. and the important sense in which amity is right and the policy mix we'll talk about is try to advocate is what set of policies both give us good economic growth and broadly shared economic growth so amity chalets was right. now, nikita khrushchev was

wrong. but here i have in mind something in particular. one of the famous kitchen cabinet debates between vice president nixon and khrushchev was over what indicator was the sign of prosperity in an economy and how do you fight that on you? -- out? and to premier khrushchev was obvious, it was the rocket thrust. it was the symbol of soviet power and his version of soviet growth. vice president nixon, after some heming and hawing, defined color television as his indicator. now, when i speak to young people i remind them that in those days, this debate happened the year i was born, it was in a long, long period ago -- in those days color television would be like talking about the ipad today. it wasn't that nixon was in a fog somewhere. he was actually talking about something quite important. but the real answer to why

khrushchev was wrong and frankly why nixon got it wrong in his debate a year later with senator kennedy was that economies that have better innovation and growth wind up with both color television and rocket thrust. so growth is the answer. now, the book is not a doomsday book. i know it is very fashionable and every time i have lunch with pete peterson i'm reminded of this fashion to have a root and branch discussion. and there's a little bit of c cal -- calvinism. and pointing to things that might be. but don't have to be. peter and i are very much interested in long-term problems but we will not be offering a kind of liquidationist eat your

spinach kind of medicine. now, to frame ideas, i want to start with something that we have all lived through and sadly are still living through and use it as a microcosm of why we've gone astray with excessive focus on the short term and inadequate attention to the long term. and so what i want to do is use the financial crisis that had its largest impact, the 2007/2009 period but one in which we are clearly still living today as a microcosm. and i want to talk at the risk of oversimplifying about two versions of the financial crisis. so as not to editorialize, let me call them simply a and b. now, the a story i will describe as mildly victorian because it reminds me of my mother and my mother always believed that where there was pleasure, pain could not be far behind.

and the victorian story is somewhat like this. what we went through was a period of excess and private markets and it caused this excess and bubbles. the damage that happened in the economy was deepened by the rot in the financial system, poor incentives, lax lending standards and resulting loss of wealth of financial institutions of investors of taxpayers. the cure in this story is, well, let's get back to normal. and the way we get back to normal is a couple feel ways. one would be countercyclical policy, to prime the pump, to stimulate ourselves back to a reasonable trim growth quickly and the second would be to rush for financial safety. and we've seen this most recently in say the dodd-frank

to move to the safety. now, the b explanation is somewhat different. the b explanation says the financial crisis really didn't start in 2007. it actually was the product of quite a long period of time of long-term structural imbalances. principally but not exclusively is the american economy so much toward consumption, so little toward investment. that mirrored -- that was mirrored by a policy orientation in key emerging parts of the world that played the mirror role to also their own detriment. at the same time in which in which this imbalance is occurring which cause this imbalance at least in the united states, we're a set of public policies exacerbating the tilt to consumption. i'll be specific about these as i go.

but since we're talking about the financial crisis as a microcosm, much of this had to do with excessive focus on the housing market at the -- to the detriment of talking about other forms of consumption or more importantly, investment. story b, like story a, realizes that the shocks, whether they were just the bubble in story a or the long-term balances in story b deepened their effects in the real economy through financial propagation, in particular the banking crisis, the shadow banking crisis in the united states. but the cure in story b is very different than in story a. it emphasizes structural reforms that would tilt the ship much more toward investment and away from an excessive consumption

and it would tackle reform to balance two things, a natural concern over safety in the aftermath of what we went through but also a healthy concern for vigorous intermediation and growth. now, this idea of the financial crisis as a microcosm or a metaphor for this tension in what's been going on in u.s. policy between the short term and the long term t's up really two themes that i want to talk about that's a center in the book this morning. the first theme is that we have been through a series of policies sometimes deliberately more often unwittingly been papering over long-term problems that exacerbate, in fact, short-term problems. a clear example of this is the housing bubble where rather than addressing long-term problems in capital accumulation and in

sluggish at least in the past of money growth wages, we instead resort to cheap credit and financial interventions designed to target growth in the housing market. i'll come back to that. the second example of papering over the long term to focus on the short term comes in the tax area where our repeated failure to be serious in talking about tax reform isn't just something that causes academic economists pain. it leads to crazier and crazier short-term policy. i'll come back to this in a couple minutes and we are living through that drama today. another area is financial regulation where our inability or our unwillingness which is to tackle long-term problems of too big to fail, of the housing finance system in the united states have led us to paper over

problems in the financial system each time leading to a different bubble and finally entitlements where our repeated failure and the housing market have led us to focus on rounds and rounds of discretionary policy with very little success and very little success with either political party that has proposed them. theme number one that i'll argue is we're page the long term in the short term. and theme number two i'll come to several times is about principle over principle, by which i mean which we talk about reform in washington we typically talk about principal pal and this is about secretary

geithner talking about it and whatever we're talking about have to be of a certain size. that discussion often happens with unfortunate inattention to principle which is pel which is exactly do we want fiscal policy to do. how do we think about saving and investment in the united states? what role do we really want entitlements to play and what role should our tax system play? the consequences, peter and i argue, have been a couple of problems one in the here and now and one that's scarier in the future. in the here and now, if you look at the decade of the 2000's and the first decade of the 21st century, we argue that a growth deficit relative to the growth that we had enjoyed in the prior part of the post-war period probably led to as many as 10

million foregone jobs. the thrust of the book is not that we need a new stimulus package to bring those jobs back. but that our repeated error to focus on the long term cost us those jobs. the bigger issue we agree is not so much the mistakes we made but the mistakes we might be making, that is our now failure to address entitlements, our now failure to address tax policy, financial reform and so on could retard the fiscal's policy decision that we could no longer provide the services americans take for granted. by which i mean defense of the country and the free world. other public goods relating to research and education. all of these are imperiled by a fiscal policy and a growth policy that are off-track. now, i said this is not a doomsday book. nor is it a cookbook.

if i had a silver bullet, i would certainly tell you there are important levers of growth. on the other hand you're going to look at a list like this and say it's familiar. but it does have an eery feeling to it and all the things that i show on the slide represent structural factors in growth. if you talk to economists, they are the kinds of of factors that you might hear from economic historians if they were trying to tell you about the industrial revolution or if they were trying to tell you about periods of wealth creation and growth more than sadly than if you were to talk to current policy practitioners who often thinks what it takes to move gdp this year. there are only 10 but 10 consistently worthy of mention of free markets which peter and

i have a discussion in the book that's a p in benefits to the competition and political transparency. free trade which is much in vogue in discussion but not really in practice. the benefits of free trade that we talk about in the book are not so much the ones you hear often which are variety and consumption but ones you hear less often. the importances of free trade in bringing competition and productivity growth to the nation and as being an important part of a policy pivot for a nation that too long has run large current account deficits. the third is vibrant entrepreneurship. and here we tackle in the book the notion that all entrepreneurship is about creative destruction. indeed, much of the policy fear of entrepreneurs is precisely because of the metaphor of creative destruction, destruction scares politicians. we actually argue in the book

that most of in the entrepreneur that a century or so ago looks like nondestruction creation, new markets new instruments, new ways of doing things with a different kind of policy emphasis. fourth, we need some saving in this country. the notion that we can finance investments simply by turning to the international capital market works at a moment in time or indeed as we have found at many moments in time for a long period. algebra don't even need economics for this tell us it can't work forever. and the u.s. does need to raise saving. but fifth, just as important as raising saving, we need a financial system that works well in translating saving to investment. now, this has been one area in which the u.s. has excelled in most of the post-war period despite the problems that we know about from the financial

crisis. this is a good news story but it is a story that is imperiled given public policy's recent emphasis purely on the consumption aspects of finance and not its aspects for intermediation investment. innovation is critical. it is not just about labor and capital. but about the speed of innovation. and again, policy's fixation on ever higher marginal tax rates and higher shares of government and gdp put that in peril. the rest of the factors are capital. we have a-an energy policy that has not blunted the oil price shocks on growth, either the supply side or the demand side. health care is not just an issue for the obvious link that we would all like to be healthy and healthy people produce more. but for the length that efficient, health care financing is important for the budget and for economic growth. and then finally we have a small

p in the book to manufacturing, something quite out of fashion apparently in much of washington discussion. manufacturing matters, too. in no small part for r & d but also for something less celebrated by economists, a kind of shop floor innovation where you have to have the facility here. now, while these subjects are talked about a lot, they're seldomed practiced in washington. in fact, what we have done in the past decades in both political parties is champion consumption over investment. build a financial system around consumption and pay inefficient or insufficient attention to trade. now, what do we do about this? i'll mention these and then do a handful of little case studies. peter and i outline what we call a seeds of prosperity blueprint. this is not a cry in your beer book. and if you were to look at all of these and say, well, what one or two things tie them all together, it's really a couple.

one is you got to put the long term first. and as i'll argue in a moment that is not tantamount to saying eat your spinach in the long term, there could be important short term benefits by putting the long term first. the second lesson is don't try to use a single instrument to hit two objectives. and the two objectives, sometimes championed by the two political parties, but certainly two reasonable objectives to talk about, are growth and fairness. the points we make in the blueprint in the book are about several things. i'll only talk about a few of them this morning. i'll be happy to answer questions on any, one is about recasting monetary policy. we argue in the book that monetary policy has gone astray in recent years. excessive focus on the short term too with too little regard of long-term objectives of monetary policy and excessive

politization of the federal reserve. re-arguing the fiscal stimulus and it's being argued too many times and we try to attack a structural problem with cyclical measures. the ones in my tallics i'll -- italics and i'll talk about them later free and trade policy is how you do we champion the benefits of free trade for productivity and jobs. and how we can try to focus on trade agreements in fact rather than just sending the leader of the free world to seoul to mention their name. energy, we argue in the book and i'll mention a specific example in a few minutes that there is a smart path to greater energy independence that falls squarely in the middle of arguments you hear on the two sides. social security has got to be the centerpiece of any near-term

fiscal consolidation effort. it will give you a plan. health care, we took a very wrong turn in recent policy by focusing on a short-term concern, access, rather than the long-term concern which is cost. most economists, if you speak to them about health care, irrespective of their political persuasion, would tell you if you could get costs under control, you could improve access. few would tell you to start the other way around but that, of course, is what we just did. medicare and medicaid's need to be repaired follows from that kind of health care debate. we'll talk a little bit about preventing another financial crisis. now, in putting the long run first, i'm going to choose three examples and if there's time i'll talk a little bit about energy as well. and i'm going to pick as three main examples tax policy, social security and financial regulation. these are three of the areas in the seeds of prosperity

blueprint. and i pick these three because they all fall into a trap. and in each case, policy has been mired in a trap that's not because people aren't intelligent. it's because they've constrained the problem simply to think about the short term and not the long term. and here -- let me start with tax policy where again under both republican and democratic administrations in recent years, we have slipped into what peter and i have called the keynesian consumption trap. the keynesian consumption trap -- or you could call it the more money and people's pockets trap to quote my former boss, president bush, in talking about tax policy changes -- that trap centers on marginal propensity to consume out of tax changes in the near term as the touchstone of evaluating a tax policy. now, that has a couple of issues

with it. one as economists would tell you, it is very short-term focus. it would become critical from a theoretical perspective to know whether you're talking about a marginal propensity to consume out of a temporary tax change which would be very modest in most economic models versus marginal propensity to consume out of a long-term tax change which would be much longer in most economic models. it is also problematic because it leads you to miss an argument about the centrality of marginal tax rates themselves none of judging tax policy. and the intuition that's familiar from a first lesson in public economics that the distortions of marginal tax rates are higher, the higher is marginal tax rates. now, why this trap has been important by both sides allowing them to fall into the more money in people's pockets trap, we are mired in a debate over whether

it is the case that high incomed people will or won't save the more of the given tax cut rather than focusing on the effects of marginal tax rates on saving, investment and entrepreneurship or failing to realize that about half of people called high income or about the top 1% of u.s. taxpayers are business owners and it's not likely a consumption problem they're solving but rather an investment problem. one could get out of that trap, if you wanted to, focusing again as amity teed up with growth and prod base prosperity by saying why don't we have a system that has low marginal tax rates but doesn't have big average tax rate cuts, average tax rate cuts for high incomed people and i'll give you an example of that. social security, we have fallen into this principal versus principle trap by saying no. what we really care is something about size.

so we worry about social security deficits and we will change benefits and taxes to meet some deficit target. as opposed to stepping back and asking what the heck do we want this thing to do? i'll give you an example following an example of growth and broad-based process prosperity. and the trap we fell into was housing. both parties came together to say housing was a way of papering over the way people were financial and broadning housing finance further and further down the income scale we could have a bigger effect. to do so this we would need to loosen lending standards. we would need to use government sponsored enterprises to carry out a mandate that few in the private sector would do on their own and that, in fact, what we did. that trap leads you to trying to

close the door with an excessive focus on safety rather than on health. and again, there is a way out. now, let's talk about tax policy for a moment. the objective for tax policy is really about saving investment and growth. we don't have to use the tax code alone to hit distributional objectives. we have something else in the federal budget called spending that is very capable of doing that. and tax policy can be used in part for fairness but fairness shouldn't be the centerpiece of setting tax policy. now, the problem with the trap of falling into the mpc or the marginal propensity to consume argument is that what we've done is center the debate not over the objective that peter and i mentioned, that i think any economists would mention, but rather on the fate of the bush tax cuts. is that the entire internal revenue code could be described by the 2001 and 2003 tax cuts.

and has led to three rat holes of policy discussion. rat hole number one is repeal the 2001 and 2003 tax cuts. now, this is a rat hole because in and of itself repealing the tax cuts would be close to the largest tax increase at least in recent history without any discussion of off-setting policies for growth. it would certainly not be the way economists would tell you to go about a deficit reduction in and of itself which generally centers more on spending cuts. a second rat hole is, well, why don't we extend all but the high end tax cuts? secretary geithner piously said this was the way that the u.s. could convince the rest of the world it's serious. unfortunately, that gets it exactly wrong. it would show the rest of the world we are unserious. these tax cuts on high income households, while very small

compared to the size of the deficit in the tax figures the administration uses something like $70 billion a year against $1.4 trillion budget deficit, they are the ones that have the most significant effect on growth. indeed, the sense in which secretary geithner gets it wrong, we want entitlements. the third rat hole is largely a republican one. and it's extend the 2001 and 2003 tax cuts permanently. now, that's a rat hole because this set of taxes enshrined in the current internal revenue code would not be where i think most economists would start if you were trying to think about big reform of the tax system. some elements of it, yes, many elements of it no. a better answer would be to extend for a while until we can have a real discussion.

what can work here, peter and i argue is, low marginal tax rates gens because distortions are higher, the higher the marginal tax rates. an emphasis of investment incentives and narrowing tax preferences. that is it doesn't have to be the case that low marginal rates are associated with low average rates for a given taxpayer. one could achieve that kind of revenue without distorting marginal tax rates. while a good long-term objective is something like a broad-based progressive consumption tax, there are many, many good ways to start, but they all share this focus on lower marginal tax rates. now, social security begins with the problem, again, principal versus principle and this problems comes about because we tend to use the word "deficit" a lot. economists don't like words like deficit because they come from accounting. i teach in a business school and

accountants make more than economists. they know a lot more than what we do but i can tell you deficit is a term that lacks economic content. there are two components of a deficit that do have economic content. one is called taxes. and the other is spending. so when we look at a proposal -- the question is not what it does to the deficit in social security or the overall risk, but what it does to spending and taxes. now if we ask ourselves what do we want social security to do, we can avoid unfortunate rat holes. the rat holes here are payroll tax increases, which we know suffer from the high marginal tax problem and other spending cuts. i mentioned at the beginning of the talk, if we don't get this right, and we don't counter-with taxes we will simply not be able to defend the country or pay for education in the end in present value terms, the budget must balance. what we can do is try to reduce benefit growth for middle and

upper income households. there are many, many ways to do this. no single proposal but all of these proposals would get it right by saying, yes, we need to bring the system in line but we need to do it in a way that doesn't damage broad-based prosperity. now, what about financial regulation? back to the objective, here we want to talk about plumbing to enhance in an able-balanced growth. i say plumbing because the financial system isn't supposed to be the sexiest thing in the economy. i'm sometimes distressed at the number of my students who are focused solely on finance as opposed to other limits of the economy. finance should be plumbing but very good quality plumbing. like you would want in your own house. what can't work is the overemphasis of house that we have pursued in public policy. it's not just because we get too much housing. it's because we want to wind up distorting the entire financial

system as we saw with the entire edifice of securities that was built on top of what used to be simple home mortgages. and we also can't do this by focusing simply on safety. safety is a kind of cheez whiz strategy in which all we do is wind up holding cash or treasury bills but with little ability to generate appropriate levels of risk in lending. what can work is really three things. radical mortgage reform. i'll just mention this. it's talkeded in the about this. a removal of the major government role we had in the gse's and a rethinking of mortgage contracts that provide better insixteen to his on capital reform, rather than just saying hold more, more, more, the desire is to think about what do you want capital to do is a discussion of a familiar proposal of economists on how to develop and design practically

capital requirements that move over the business cycle. and then finally on systemic risk, really focus on the elephant in the room which is a credible end to too big to fail. while that's featured in a lot of discussion of dodd-frank it's largely silent in the actual law. let me just mention quickly and we can come back to it in q & a if you'd like. one area we also talk about in the book is energy policy. and this is an area, too, where i think there's a wonderful compromise from an economic perspective between what republicans have argued in energy policy and democrats. and here the goals is to reduce the damage from oil price shocks and also recognize externalities in oil consumption. many people focus on environmental externalities. in the book we also talk about national security externalities.

what can't work here -- two rat holes that we've been going down. one is what i'll call the independence myth in economic terms we simply will never import energy that's not realistic. and the second a kind of science is manna idea that if we just wait long enough, technology will happen. most business people respond to incentives. one thing we talk about in the book is an oil price floor as opposed to a cap-and-trade or simple tax that makes sure that oil prices don't fall in the u.s. below a reference level, which removes uncertainty in innovation. so obviously a tax is required to do that. to tie all this together, to wrap up, all of these examples have something in con. there's a single key that unlocks change and that's thinking about the long term. i've made economic arguments with you this morning. but even though i'm not a politician, i'll be bold enough

to argue with you that there is some political salience here, too. start with the social security recommendation for a safety net entitlement system. from a point of view, that's to reduce outlays and get rid of required tax increases from a democratic point of view, it focuses on guarding against poverty in old age. tax reform from a republican point of view, the plan that i outlined would address the need to pivot away from consumption toward investment and trade. from a democratic point of view, it would address wage growth in the long term. the financial regulation policy from a republican point of view would strengthen financial intermediation and innovation. from a democratic point of view, it would minimize casino incentives and poor consumer products and finally the oil price floor would have

market-based innovation incentives perhaps from a republican side and address green concerns more from a democratic side. to wrap up, there are two ways to think about policy. we've been using the top one of these. it comes from lord keynes in the long run we're all dead. but thanks. [applause] >> >> thank you very much, glenn. i guess i would summarize your comments as saying that we've been using a cheez whiz strategy to get out of a rat hole. [laughter] >> but i guess the cheese probably lured the rat into the hole in the first place or something. so we've got two discussants. the first is ramesh, he's senior editor for national review covering national politics. he's written for the "wall street journal," the finance times, news day, the "washington times" and many other publications and is the author of the aei monograph, the

mystery of japanese growth. which i think will segue nicely into the conversation i expect to have with both discussants which is that there have been some experiences of being in rat holes in the past around the world. and some folks have tried to -- tried different things to solve their problems. and what we'd like to do is begin a discussion that takes your proscription and compares it to things that have been tried in the past. and so with that -- and also the political feasibility. so why is it we keep doing the wrong things and so on. with that i'll turn it over to ramesh first and then i'll introduce carmen after ramesh. >> thanks, kevin. let me just start by agreeing with professor hubbard nothing says christmas like "seeds of destruction." i agreed with a lot more than in this book than i disagreed with.

in particular, i would say that i'm much more keen on amity on her ideas than nikita khrushchev if that's the choice before us. but as a journalist i'm supposed to prize conflict so i'm going to spend more of my time today talking about the things that i disagreed with but let me start with the areas of agreement. i think one of the really interesting things about this book is the way that it starts with perception -- in many areas, it starts with perceptions and insights that are more frequently associated with folks making the sort of antifree market more interventionist argument business economic policy but then moves from them to pretty conservative conclusions. i think that's true about the discussion about china, that's

true about the discussion of manufacturing. and one place where i think this book makes a real at least rhetorical break from a lot of center right commentary off economics is that there's, i think, a really sound understanding that our goal should not be to simply restore the economic status quo before the financial crisis. there's an understanding that the economy was not in good health during what most center right economic commentators, at least judging from the public rhetoric is the boom. in some cases conservatives will talk about the bush boom and act as though that's what we want to get back to. and i think for a lot of reasons, including wage stagnation and it's a mistake that this book very wisely avoids. on policy, i think the book

makes a strong case for a progressive consumption tax but then since i already agreed with that before i started the book, i guess i'm predisposed to thinking that. indexing of social security benefits so that initial benefit levels rise with prices and not with wages, i think is another great policy. clearinghouse for derivatives. all of this i think is great stuff and if adopted would be very large steps forward for this country. then where do i get my disagreements? let me start with health care. and even on health care, a lot of my fundamental policy conclusions are very much in keeping with those of the book, but in some cases, i would get

there in a sort of different way. the book repeatedly describes rising health care costs as our principal problem in the health care sector. i'm not sure i would regard it that way. i think there are reforms including many of the reforms they talk about which would get us better value for the dollar, more individual control, more satisfaction but, you know, if 30 years from now health care spending as a percentage of gdp is higher than it is now, or significantly higher, that is not something that i think is problematic. i think the countries as they grow wealthier are likely to spend more on health care and i don't think that economic policymakers should think even in the back of their mind that there's some sort of correct figure for health care spending or health care spending over gdp that we ought to be aiming for.

that is to say, some of the right policies might at least in the short run could health care policies to go down but that shouldn't be the principal goal of those policies. i also don't think things such as the infant mortality rates and the life expectancy of this country are strong evidence about the efficiency of health care spending in this country. i think there's a lot of reasons for thinking based on, for example, our lifestyles that those numbers would be likely to be worse than those for other countries for reasons that don't reflect on the efficiency of our health care spending. on medicaid, the policy recommendation in the book is to have a capped block grant to the states where, you know, the states pay out from the federal government would be based on population plus inflation which i think is a perfectly good policy.

again, a very big step forward. here my disagreement would be more rhetorical. what you get is increased state flexibility. the problem with medicaid is you've got all of these rigid sort of federal guidelines and micromanagement. and certainly that is an element of the problem. i think the bigger problem is the lack of accountability on the states. the fact they are essentially given a blank check to spend more money knowing that somebody else is going to pick up half of the tab. so the problem isn't -- and i'm borrowing here from the terminology of aei scholar, michael grieve, the problem isn't that it's an unfunded mandate. the problem is it's an unfunded mandate. and then last on medical malpractice, i just simply disagree that we should have a federal reform of medical malpractice laws. they suggest that there should

be a reasonable cap on noneconomic damages. it seems to me it's not clear that's the best approach even if it is the best approach, it's not clear what that reasonable cap should be. medical malpractice strikes me as a perfect area in tort law where the flaws of a state's policies are almost exclusively bourne by the residents of that state. so why don't we have laboratories of democracy? why don't we allow states to bear the cost or reap the benefits of their different medical malpractice policies. i think we want -- we should want to punish states for having lousy political cultures that drive doctors away and we should want to reward states for improving their political cultures and getting better policies. and i think that is essentially the system we have. i don't see any good reason to change it.

turning to other areas of the book, on fannie and freddie my principal disagreement like a lot of reform proposals i don't think this one goes far enough. they talk about -- and a lot of places they talk about their ideal policies and what sort of the political compromised step forward should be. i think the politically compromised step forward should be to really disentangle fannie and freddie from the taxpayer. and from federal support, a step that might very well mean ending these institutions. my ideal policy, however, is to either burn or raze these buildings to the ground. i'm not dogmatic which method, salt the earth and then put a sign there saying these are the wages of sin. >> and you thought i was

victorian. >> i think the blanket hostility in the book toward adjustable rate mortgages and interest rate -- excuse me, interest-only loans is unjustified or not justified by the argument presented in the book. i think that in some circumstances for? -- for some people who know what they are getting into, these mortgages work fine. i'm biased here because i'm speaking both from personal experience. on oil, energy policy -- although the rhetoric of addiction is popular and bipartisan, i'm not sure it's apsit. we don't typical think of something that's cheap and useful and, therefore, use in great quantity that we're addicted to and i think there's a real political naivete to the

suggestions on energy policy. it's all well and good to suggest a policy that reduces volatility of oil prices but i don't think price shocks per se are unpopular. people really like positive price shocks, and i think it's going to be a hard sell to get people to say, well, we're going to reduce the likelihood that we have a downward shock in oil prices. let me put at this way. if i were -- if professor hubbard were running for political office on this platform against a candidate who, say, had a particularly lured sex scandal, i'd bet on the sex scandal guy. [laughter] >> and finally, on the china question, of i'm not really sure what the up-shot is -- you know, what we should really do

vis-a-vis china. i mean, there is some gestures in the direction of let's really get tough with them on currency manipulation, piracy and so forth, well, what form does that take? what are the possible negative consequences of it? and i guess one last thought -- reading the china sections, it struck me as reminiscent of nothing so much as the book is about japan that i was reading two decades ago about how the japanese were eating our lunch. and we really had to be sort of terrified into changing our economic model, that i think proved out to be mistaken. it doesn't mean it's mistaken this time handwritten but it's just a similarity that i found quite striking. and with that i will yield the floor except to say i thank professor hubbard and his co-author again for writing a very stimulating, interesting

book. >> thanks very much, ramesh. chad is going to be loading carmen's slide. carmen reinhart is the co-author of this time is different, eight centuries of financial folly. i think it's safe to say that book is -- turn on the screen, chad. yeah, there we go. i think that it's safe to say that book is really the most influential serious book that i can remember in my lifetime in the economic sphere. it's been a huge success because it has so much wisdom of history in it. and i thought some wisdom might be an interesting thing to bring to bear to this discussion of looking at past history and seeing whether, you know, the crisis of capitalism that motivated in part the start of this book is a kind of common experience in past crises.

carmon was recently appointed as the dennis weather stone fellow at the peterson institute for international economics so she's joined us here in the think tank community after being a professor at the university of maryland for many years. carmen? >> thank you for that wonderful introduction. well, let me begin by saying that i share much of the diagnosis and much of the proposed cures that are laid out in this book. and i will delineate where my thoughts coincide and also where my thoughts depart. i think we have greatest departure on monetary policy and more broadly defined financial sector on the whole. let me also state at the beginning that the elephant in

the living room that i will be addressing, that is importantly addressed in the book through the talks about the needs to deal with entitlements, need to deal with savings incentives -- the elephant in the living room that i'm going to be addressing throughout is debt. government debt which keeps rising as far as the eye can see. and contingent liabilities of the government. as i said, there's a great deal said in the book and i will refer to that about this but also private debt. since the federal reserve began to publish its statistics on government debt and the flow of funds in 1945 but the historical statistics of the united states go back to 1916. i can say that since 1916, the

level of public and private debt in the united states at present is unsurpassed when you combine public and private. when you look at public alone, only one year, 1946, right after world war ii, was public debt, bigger than it is now. that's a running theme that i will come back to. so the elephant in the living room is -- well, what do you do in a decade in the aftermath when you inherit this large stock of debt? i mean, any policy decision has to be informed by the fact that we have this debt overhang. that's going to color not just -- i'm not talking about cyclical policy. i'm talking about structural policy changes which i will go through.

and this elephant by the way is not a baby elephant. it's not an adolescent elephant. this is an elephant with large hips. so what the starting -- the authors pretty much convincingly tell the story, look, we have an incoherent tax system where there's a lot of favoritism towards borrowing, towards consumerism. this is nowhere clearer than housing. we've had already three years after the crisis plenty of evidence of inefficient fiscal stimulus. please tell me if i mischaracterized them. they have multiple laser of regulation that often have -- during the run-up to the crisis contributed to it and we really haven't dealt with

satisfactorily since. and we -- you know, if our longer term objective that sort of desired 1950s outcome is an era of greater growth, we have a misalignment of incentives away from capital formation and moral hazard is everything. >> i'm right on the board when the authors are talking about about the too big to fail problem. if we think we dealt with the too big to fail problem. think again. too big to fail is alive and well. here just sort of drawing on a little bit the aftermath of financial crises. let me just state, this is not about the immediate aftermath but the decade after a major financial crisis. these are the economic

environment in which any changes in policy are likely to take place if history is any guide. it's the decade -- this is based with work on vincent reinhart at the aei and my earlier work with ken ro-goff. this is a paper we presented after the fall at the jackson hole federal reserve symposium. and we basically said, look, if you compared the decade before the crisis to the decade after the crisis, the decade after the crisis is -- if you think the title "seeds of their own destruction" sounds gloomy, it's -- it's not -- it's not an understatement to say that the decade after financial crisis is a gloomy decade. it's characterized by lower

growth, higher unemployment. and lower housing prices and this is -- this is important also when it comes to that sacred cow of deal with a removal of tax incentives and interest deductibility and such because that's the environment in which policy choices are going to be made. one criticism that i have of the book is that i was left wanting to hear more about the issue of timing and sequencing of some of these policies. that i'd like to -- you know, because, look, it would have been an ideal time to remove the interest deductibility of mortgages during the height of the boom. ..

>> this is only the leg of the elephant. it basically shows public debt in the three years after a severe financial crisis. it's not that of gdp, but if you were to take debt to your the crisis, and our? 2007, and ask yourself what happens in the first three years after a financial crisis, the average increase in public debt is about 86%. in other words, public debt

nearly doubles. when you take into account -- this is not take into account implicit guarantees and assume things like fannie and freddie, which in the first quarter of this year alone was explicitly included in the government's account, and it amounted to about 27 percentage points of gdp. so if you take the following, follow me for a moment here, flow of funds, net central government debt plus state and local debt, plus a debt of government enterprises, which as the first quarter of this year includes fannie and freddie, we are at 170% of gdp, only surpassed in one year, 1946. so the whole issue of the indebtedness going forward means -- by the way, it's very much

central to a point that is at the heart of the book, that what can you do, what can policy due to foster growth? in recent work, or more recent work with ken rogoff, short paper called growth in the time of death, we highlight that countries with a high stock of debt, debt levels, public debt levels above 90% of gdp, growth rates are lower. so the point i am making, all these commentary about debt and the aftermath of crises is we are starting out from a hole. and so, and we are starting out from a hole that involves high in indebtedness which also brings me to the issue of monetary policy.

now, in retrospect in many dimensions, but let me say that in the aftermath of world war ii the united states and most of the advanced economies that have inherited very large stock of debt had far from independent monetary policy. and there was an era of financial repression which -- what is financial repression mean? i am saying this because what may be the golden rule for a long-term desirable stability of the price level and what you would want a central bank him is not what the central banks in the united states, the u.k. and other advanced economies is when they face high levels of debt. it wasn't because it was desirable. it was because it was expedient. and what is financial repression? financial repression actually combined caps on interest rates

or keeping interest rates low. having a high share of marketable debt in effect in 1951 and united states. we had a conversion of debt that took marketable debt and made it nonmarketable. and the aim is pretty much the aim that we are seeing all over the world today, which to have a higher chunk of debt in which you don't worry about rollover, in which interest costs are low. and a little bit of inflation. and that little bit of inflation combined with low interest rates in these large captive audiences was a major factor in liquidating our debt after world war ii here in the u.s., in the u.k., and australia, and in most of the advanced economies which at the time inherited a lot of debt. so, the taylor rule is nice, but the taylor rule really came

around at a time in which we were facing very different, a very different economic environment, that which we have inherited today. so, i practically agree with everything that is said about needing to change tax incentiv incentives, about the fiscal thrust, about regulation. but in monetary policy, i really have my doubts about what realistically we can expect in the decades to come. if we look at this last episode of high world in indebtedness, because this is not just the u.s., but it's also the u.k., it's mostly the advanced economies, what to expect on the monetary policy. now, i do share -- i didn't know

this, but like glenn's mom, i'm very victorian, and so my last commentary is going to be on monetary policy. and more importantly, the feast side, the victorino east. that victorian feast -- this is important looking for because one thing where we are not -- the '50s is not a very good guide in how integrated we are into the rest of the world for better or for worse. part is that monetary policy does in the u.s. and part is what our confounded external imbalances continue to do, which is provide a continual source of financing from abroad. that whether we like to admit it or not actually undermine our monetary policy of autonomy in a big way. the reason i say this is not to,

you know, i think of you which this is i think it's fast, not embraced, but espouse is we deviated from a table. i've heard this from taylor himself many times. believe me. we deviated from a terrible rule and this is a contributor to this crisis. i just don't buy that. we have massive capital inflows, purchases of u.s. treasuries from central banks that toward the magnitudes of qe2 and to be one. u.k. have massive capital inflows. i'll have massive capital inflows. spain have massive capital inflows. capital inflow is just a polite way of saying you borrow a lot from abroad. in an effect, you know, when you look at monetary policy and what we can or cannot achieve domestically, the correlation

between the federal funds rate and long-term mortgage rates is a very weak one in this area of global capital. so what i'm asking the authors to think a little more about is, is how do you should monetary policy in an environment which is a, global in which we have it lot of debt. it's not going to be a taylor rule. and detainable about i think, glenn also raise the issue, we can't have too few instruments will have too many goals. and if the estimate is also avoiding another credit boom like the one we had, a lot of credit was fueled by being able to borrow from abroad. i think we also have to look at more '50s down measures in which, you know, old-fashioned tools like margin requirements and other things that discourage

indebtedness. they might not be pretty but they may very well be expedient. so to wrap up, let me say i very much enjoyed reading this book. a lot of the issues, you know, the articulation of things, you know, pertaining to, just really how messed up our tax system is come and believe me, when i say, when i don't talk about current account deficit and borrowing from abroad, i trace that importantly back to our tax system because that's key determined at saving and investment decisions. so it made me very, you know, think very hard about these issues.

in terms of the proposed solutions, as i said, it's impossible for me to read even my own work without agreeing on everything. i think, you know, we have to, number one, think about more of the timing of these things in light of the fact that the aftermath, the financial crisis is particularly vulnerable period, how you would bring, how you would sequence and bring these into and secondly, i think the debt overhang that we have we cannot make disappear. the way that you make it disappear is through default, through partial restructuring, through partial default which is called restructuring, through growth which cell phones happen -- which is seldom happens to get through some combination of, it could be, doesn't have to be the big blowout variety that

we've had in many emerging markets, or in germany after world war i, but the way we did it in the '50s, the way we did in the '50s and the '40s, in a recent paper financial repression, i calculate the liquidation effect, how much debt was liquidated through a combination of very low interest rates, low interest rate policy segmented markets and little bit of inflation. but it was the equivalent of raising two to 4% revenues as a% of gdp in the u.s. through the late '40s and through the '50s. for the u.k. it was actually even higher. and for australia it was even higher in the early '50s. i want to send them back to the working board on monetary policy. >> thanks very much, carmen. i think glenn, before we open up for questions, do you a minute

to respond or i have one question for you before you kick off a response, which is the seeds of destruction, you say that they were planted by both parties, which in some sense means that you yourself are kind of a farmer, right? like you were there as the chairman of the council of economic advisors for president bush. do you think that this book reflects a change of heart for you? or is it more that you think that you've sort of saw this coming but you are unable to get the politicians to listen back in anger hoping to be more successful than? >> i think i can answer that question at the end. no, i didn't -- i think it is both parties contributed. i think there are good elements. if you take the bush tax cuts, something i've thought a lot about, they're somewhat of a list of the bush tax cuts, some

particular once i am very fond of. but suffice it to say, the step of policies that were followed not just an attack say about the whole area, all policy did exacerbate the problems that carmen mentioned, excessive leverage in the economy. i don't think that any one person gets blamed for that, but it is certainly something that both parties acquiesced to. both parties acquiesced to the housing subsidies over time. both parties looked at tax policy through less than progrowth lives. i think that's a change of heart forward. i can recall making this me to be the only person that opposed medicare comment but there it is. >> you do that right before you departed. >> that's true. [laughter] that's true. i'd like to thank ramesh and common for wonderful comments are a few things on health care,

i agree with ramesh's observation that the book i wrote with john kogan and dan kessler called healthy wealthy and wise, it's smalloutfits and a stocking, about to be reissued. it is about value. talk about cost of the book but it is about value. every reason to believe we are not getting value right in u.s. health care and cost are too high from a value perspective. ramesh is right on medicaid. the key issue in medicaid is the formula you choose in the block grant and then it isn't thinking corporatization, ending states getting to spend other peoples money. in fact, jon and dan and i argued it's a matter of what form that you sent. be as generous as you what with governors but stopped ago participation in your way ahead. on adjustable-rate mortgages and interest rate only mortgages come what we are because we got to go back, peter and i argue that we have to go back to a kind of regulation that limits

contracts by wealth levels. i have no problem with affluent people of any kind of contracting want, but it was ironic that a wealthy person buying an apartment on park avenue in my hometown had a simpler contract than many low income families of subprime mortgages. that's not the way we do anything else in regulation from hedge funds to private equity. not the way we want to do here. on energy the addiction is harmful because of the national security externality. it's not addiction to things coming out of the oil in the ground in texas. it's coming from places that are trying to harm us. on china there is i think a different from japan. i'm one of the ones who wrote quite critically of japan is going to eat our lunch folks in the late '80s and early '90s. but this kind -- this time i'm not afraid china has a better economic model. but the global and balances are

truly a limit. i agree that debt is a of an interim but there's more that we can do about it. the big elephant in the room is entitled the debt. guys carry numbers that carmen showed us, while scary, are not the scariest. the real scary numbers are the entitlement debt. it's much larger. that we can change because we can change it with the stroke of a pin. and we can change it by limiting benefit growth and have very large effects in the long-term fiscal policy of the country. in terms of timing and sequence, we argue in the book basically you want to tackle spending first, particularly social security, corporate tax changes and the limits on deductions and i think tax reform follows for some of the reasons that carmen mentioned. monetary policy, we may disagree a bit. the '50s were also timed of william mcchesney martin who comes out in praise in the book in addition things you mentioned was also and a quarter, federal

reserve saying the way to the treasury, something that we can wish for perhaps today. the problem with a little bit of inflation, it's like capital levies in some oddball tax models that if all you had one timed wealth levy it would be distorting and you could finance a lot of things with it. the problem is rich people suspect he will do it again. and the problem with inflation is the same thing. on the table and the crisis, unlike john taylor come we don't argued that the violation of the table so-called cause of the crisis, but it probably is important in contracts that do the breath from gaps between short and long-term. >> and now i ask for questions. please ration hand and wait for the microphone. identify yourself at the start of your question, and make a statement in the form of a question, if you can. >> dana marshall, and i think glenn and peter for this

excellent book. this is the question may be to ask glenn to elaborate a little bit on it. one triangle beaches -- issues, was manufacturing. one of the good things are worth many good things about this book is it is a bipartisan, holistic and it's real in the sense that there is a focus. it is interesting to see the to discuss and didn't get much into this. this is very characteristics passionatnational characteristie discussions. that gets into questions like the real economy, like manufacturing, like innovation, and like trade. the book speaks about the problems that china has imposed on the system in many ways. you give some suggestions about ways out. i wonder if you might be able to elaborate a little bit, i know time is short, on what we can do

to rebuild our innovation system so that we not only innovate better, but that we manufacture what we innovate and not simply offshore that to increase the trade deficit which is clearly unsustainable. >> great questions, dana. on china the way out of macro and micro. macro in the sense that the u.s. needs to save rather more and china needs to save rather less, and those are both in each countries self-interest because this whole notion of policy coordination, i don't think you need anything that granted this really should happen. on a micro level i think we have to push the chinese hard, not so much on the exchange rate, but mori financial system that encourages that rebalancing. i think that's a push that is likely to succeed. on innovation i think there are two things we can do. one is obvious, the other less

audience. the one that is obvious is to continue our support for basic research. a lot of innovation in the real world has come from basic research in the sciences, and engineering that involve federal support with universities. i think that's a great thing. but i think manufacturing is also very important. and here in the book a we don't advocate and industrial policy. we say stop handcuffing manufactures, to lower the corporate tax, litigation reform, things that keep manufacturing here. the reason to do that is not mercantilism. it's the sense in which you learn something about practical our clinical innovation on a shop for. at the shop floors are not here, all the basic research in the world won't give you that innovation. so we are a little more manufacturing friendly than many conservatives seem to be. >> i guess we'll start of your and worker way around. one, too two, and then three.

>> appreciate it. first of all, on the tax code, just to give you a reference, which are doing and compliance is only one external costs and the code. gao did a report in august 20055 and he put the numbers in its more like 700 billion annual external costs. could be up to a trillion. in fact, they asked david walker about that and his response was just we stand by all of our reports. other thing is going further, robert caro, formally of the treasuries division said in committee testimony, i think finance committee in 2008, that the code could be decreasing by up to $1.3 trillion. i wanted to ask you what you thought about a 15% tax credit,

just aimed at manufacturing? i understand it's about a 20% cost difference between a chinese part here and what we can make it for. that's according to outsourcing costs index. and a corporate tax reduction, although i favor it, will not affect the past, so proprietorship partnerships, and finally, i asked you this after i generated one day, you might recall, atr assessment on all of the tax code legal system, regulatory is about 2.5 trillion annually added to the 5 trillion spending, 7.5 trillion total, 52 or 53% of gdp.

so people want to know why the economy is slow, atr as you use the 12 troika personal income as economic so they get about 60%. so typical business of let's say a million dollars of sales per year, $600,000 of their portion of government created costs on average. >> your question raises a lot of interesting issues as the high that we try to make marginal tax rates in the corporate sector or the noncorporate sector we get all kinds of tax avoidance and radio tour schemes that become necessary. the lower a marginal tax rate, not just the lower of the per se distortions that economists talk about, but the lower the regulatory apparatus tax avoidance apparatus. i don't think the idea should be to give a tax preference to manufacturing. but will you try to lower tax

burdens for all activities. so lowering marginal tax rates on individuals and lowering corporate tax rates, that doesn't have to blow a hole in the budget. as i mentioned, i didn't say it would lower the average tax rates, lower the marginal tax rates. there are ways to do that but i think are quite efficient at in the case of the corporate sector you could probably lower the corporate rate into the high '20s with no offsets because of the large income shifting potential. on a corporate site would probably require offsetting deduction changes. >> we have under the question right over here. >> my name is alex. i enjoyed the panel. i had a question specifically on the oil price tax that you're advocating. how would you estimate this tax? and if it's sole goal is to keep the price of oil high in i guess would be the differential between the market price of oil and a target price of oil, how

do you prevent government politicians from viewing this as a revenue source that does going to be the? presumably it wouldn't be there if the price of oil is high enough. how do you manage expectations on that? >> first, start of the back part of question first. we arguing about the tax shouldn't be used to raise revenue. it ought to be used that you were talking about an econ speak substitution of it effective attacks for the difference between an oil price and destroy tax, carbon tax in all tax, is we're trying to focus on the lower tail and not the whole distribution. it came about talking to executives in companies who are looking at oil saving innovation. their biggest fear was what ramesh was celebrating which is oil prices come back to being low for a period of time, the suvs are back, nobody wants to think about alternatives.

eight tax doesn't take away the state of the world. it doesn't eliminate it at the bottom. rather than having a simple tax can have one that operates only in the low price states. we weren't trying to raise revenue. it's up to politicians what to do. the argument we gave that this assembly for the price effect and we would read it the money. >> and i just clarify in response to that, the negative attack. i'm not celebrating it. i'm probably two-thirds the way convinced by the argument here. i was just make a political point about the feasibility of it. >> this is a follow-up on the last question. >> could you identify yourself. >> my name is james. you indicated earlier in the discussion that technology is a rattle. you indicated now an earlier that oil price floor remove some of the innovation. what it -- where does innovation

and with a rattle? >> my point was just business people don't innovate for the heck of it. they innovate because there's a return to that innovation. and when you're talking about long life capital, you have to be very worried about states in what the which oil stays low for very long period of time. so this wishing that people would innovate against that inserting isn't going to make it happen. i think that if energy taxes would be one way to encourage that innovation, the delicate at the state of the world people are really worried about which is that you could go through five come even 10 years of a period of very low oil prices. so i'm a huge fan of innovation. it's not innovation that's irrational. it's the idea that dreaming, hoping come hope is not a strategy. yet hoping businesspeople innovate for their own good is probably not good policy.