Open-market sustainability for the US

China and India alone will need to build cities for 675m people in the next 20 years [GALLO/GETTY]

This is the first instalment of a three-part essay that explores how the United States stands at a historic turning point. The author argues that the economic engine that carried the nation out of World War II, to then outperform the Soviets in the Cold War, is incapable of meeting the challenge of the 21st century. While the US and some other Western economies are in the throes of a rare and disruptive debt crisis, the global economy is in the midst of three additional challenges: rapid economic inclusion, ecological depletion and a resilience deficit.

Though distinct, these crises are inseparable in practical terms, forming a singular strategic test facing the US and the West. Simply put, the post-Cold War international economic system is fundamentally unsustainable. Based on preliminary estimates, a pivot towards open-market sustainability will immediately deliver the certainty investors need to put labour and capital back to work in the productive economy. Built on the bedrock of demographic demand for a new American dream and a resource productivity revolution, it will put the nation on a path to achieve climate-stabilising carbon reductions and align the US market with rising global demand. Instead of the halting multilateralism of attempts to mitigate climate change, open-market sustainability provides an opportunity to enhance our security by leading the transition to a sustainable – and prosperous – global economy.

In this chapter, the author introduces the three core components of open-market sustainability – smart growth, regenerative agriculture and a tax shift – which individually represent significant gains to prosperity, well-being and sustainability. The next chapter will examine the need for shifting to organic farming and the concluding chapter will focus on a sustainable tax shift that would generate revenue for government operations from material, energy and natural resource inefficiency – and reduce the percentage of revenue that comes from traditional sources.

Washington, DC – The modern economy experiences two types of cyclical debt cycles: the short-term business cycle that produces the familiar oscillation between expansion and recession, bull and bear; and the long-term debt cycle that we are experiencing now. During the 75-year period of these cycles, the debt-to-income profile of the entire economy gradually builds up a stock of household, corporate, and government debt that income is insufficient to service. The credit reset from indebtedness to balance is called a deleveraging.

The present US deleveraging started in 2007-2008, as rolling mortgage defaults undermined a system of extraordinary household and financial-sector leverage, triggering a shift in debt from the financial sector to a debt-burdened federal sector, through fiscal and monetary bailouts. Household debt – from both consumer and mortgage sources – remains high at a time of high unemployment (8.6 per cent at the time of writing).

This, in turn, drives household-level austerity that reinforces a negative cycle of lowered demand, lowered employment, lowered asset values and lowered government revenue. As this negative cycle grinds on, middle-class expectations are being dramatically lowered, with political implications being seen in the Tea Party and the Occupy Wall Street movements.

Today’s deleveraging cannot be softened or expedited by monetary policy – the use of interest rates and open market purchases to prop up equity markets – if for no other reason than because the Federal Reserve’s target funds rate is already zero and the Federal Reserve cannot politically take any more debt onto its books. This is not the normal business cycle. Deleveraging ends only when widespread demand and creditworthiness are restored.

Classically, such conditions are brought about by a combination of six often painful adjustments: debt restructuring (to reduce the cost of servicing existing debt); increased money supply (to reduce the cost of new debt); redistribution of wealth (to convert unproductive liquidity into widespread demand through taxation); businesses cutting costs (eg, layoffs and cutting capital investment); increases in risk and liquidity premiums (to reduce speculation and redirect investment to the productive economy); and, finally, by nominal interest rates being held under nominal growth rates (to reduce debt burdens).

Household debt

While as much as half of the private-sector debt overhang has been alleviated, household debt and government debt are still in dangerous territory. The last deleveraging in the United States took ten years and World War II to unwind, while in Japan, the 1990s deleveraging was known as the “lost decade”.

While efforts to reduce the debt dominate the discussion in the United States and now Europe, the overriding feature of the global economy is the rapid process of economic inclusion. Four billion people live outside the formal sector of the global economy – and they are coming in. These are the people, present in nearly every economy, but mostly outside the developed West, who do not have adequate access to the basic tools for living in a market economy.

They may not have a legally documented identity or title to the property in which they live or run their small business. They do not have access to credit, banks, insurance and the courts. Instead, they live in a cash world, relying on friends, family, and fate to help them weather the numerous disruptive economic and political events that sweep through their world.

But in they come. The leading edge of that human wave is rural-urban migration, where 200,000 people leave the village every day for the city. China and India alone will need to build cities for 675 million people in just the next 20 years, according to current trends. Based on income, total middle-class additions worldwide over the same time period may hit three billion. As they arrive in cities, these people gain additional legal standing and climb the economic ladder and then income and resource consumption spike – in China, new urban dwellers experience a 300 per cent increase in income over their rural past.

As a result, in just the past decade, the 20th century trend of commodity price decreases has been undone, and pressure on resources, food, water, energy, basic materials and land is unparalleled, with demand for these key resources set to increase by 40-60 per cent. International Monetary Fund commodity price indices have already risen dramatically, with significant strategic impact: rising oil prices triggered the mortgage default crisis in the United States. Furthermore, rising food and energy prices are frustrating middle-class expectations globally, having directly contributed to the protests in Tahrir Square.

China and India, needing to assure domestic stakeholders that supplies of basic materials will be available, have helped to lock in supply contracts using sovereign wealth, at a significant premium above current market prices.

With global population expected to peak at nine billion, the economic inclusion project is not only the defining feature of the global economy, it is also the driver of long-term strategic competition among the world’s great powers. From one perspective, Asia is merely springing back to its historical share of global gross domestic product (GDP) after colonial occupation and the West’s industrial head start.

At the same time, in today’s large emerging economies – supporting both modern middle classes and in some cases, billion-person reservoirs of unskilled, unconnected workers – competition with developed economies has become a race to the bottom. Able to opt out of free-trade rules, they do so, worsening the structural imbalance, famously in trade. With approximately 2.5 billion people in the formal, legal sector of a 7-billion-person economy, we are already experiencing massive dysfunction. With 3 billion more entering the middle class over the next 20 years and most of the global population increase happening within the excluded population, the pressures will only get worse.

Meanwhile, so heavy is our footprint, humans are now dominating the biological, chemical and geological processes, prompting some scientists to declare we have entered a new era, which they call the Anthropocene.

Ecosystem depletion

Those processes are determined by the earth’s endowment of natural capital, the stock of the earth’s ecosystems that produce an annual return of specific goods and services, such as climate management, freshwater production, flood control, food and fibre provision, nutrient flows, fishery management and clean air. Humanity is over-consuming two-thirds of ecosystem goods and services, depleting our stock of natural capital, reducing the absolute return on these life-support functions for subsequent years, while planetary demand for these services is set to increase.

From an economic perspective, ecosystem depletion is driven by the failure of authorities and market participants to adequately price ecosystem services in the economy. In the absence of effective pricing, ecosystem services are valued as free or, in many cases, are subsidised by national governments.

As a result, business models and development strategies around the world incorporate methods that in the aggregate are accelerating the depletion. This includes such practices as clear-cutting tropical rainforests; mountaintop removal mining; toxic releases of mercury, lead, and other heavy metals and carcinogens; eliminating wetlands and mangroves; depleting agricultural soils; nitrogen-charging of waterways; and overfishing.

The most well-documented ecosystem disruption is to the atmospheric carbon cycle. The Intergovernmental Panel on Climate Change as well as the federal US Global Change Research Programme have established that man-made emissions and agricultural practices are causing planetary warming that is having widespread and non-linear effects on the earth’s ecosystem.

If this is unaddressed, the Massachusetts Institute of Technology estimates that global atmospheric carbon is on track for 866 parts per millions by 2100, a level that will result in catastrophic climate impacts on sea level, human settlements, and agricultural production. A recent series of reports from NOAA, the National Science Foundation, and the National Snow and Ice Centre, however, reveal that observed permafrost methane releases due to Arctic warming are likely to trigger much more rapid, and disruptive, change.

Currently, atmospheric carbon levels are approximately 378 parts per million, with global emissions from energy approximately 30 gigatonnes of carbon dioxide equivalent per year. To stabilise the atmosphere, a carbon target of 350 parts per millions is required, translating to a reduction in carbon intensity per unit of GDP from 768 grams/dollar to six grams/dollar, requiring a huge leap in how we power our market economy.

Today, financial systems, ecosystem services, industrial networks, resource supply chains, and even our food systems are prone to interruption and failure. As we head into a future defined by the above three drivers of risk, our deficit of resilience will act as a crisis multiplier and retard efforts at transition.

We have already seen plenty of evidence. Poor market oversight on Wall Street and corrupted regulators created systemic risk that turned collateralised securities into toxic assets, freezing commercial lending and triggering the Great Recession. Through single-source supply contracts and just-in-time manufacturing systems, a small gasket manufacturing plant destroyed in the 2011 Japanese tsunami shut down production facilities in the big six automakers in the United States, extending our unemployment from 8.9 to 9.1 per cent.

As this is written, flooding in Thailand is disrupting Apple’s iPhone production lines. China was able to shut off supplies of rare-earth minerals to the United States, European Union, and Japan in 2010, and Russia has moved to extend and flex its considerable control over Eurasian gas and oil reserves and transit routes.

Here at home, industry and government have systematically underinvested in infrastructure, resulting in disasters such as the BP oil spill, the Southwest and Northeast blackouts, and the collapse of the Interstate 35 Mississippi River Bridge in Minneapolis – underscoring what is estimated to be more than $2.2 trillion in arrears.

Global unsustainability

None of these four issues – deleveraging, inclusion, depletion and resilience – can be solved independently. The interconnections between the four are too strong. Domestic deleveraging requires demand, but that demand runs into the hard parameters imposed by the deep pools of low-cost labour coming on line in Asia, the lack of sufficient levels of resource efficiency, and the stretched and fragile pipes of the global supply chain.

To address our infrastructure backlog requires more than just government stimulus; we need a similar deep source of private demand that can make such investments pay off over the long term. Carbon emissions need to be priced, yet cap-and-trade in the midst of a deleveraging will increase the burden of taxation on the middle class without creating a decisive framework for emissions reductions from vehicle miles traveled, housing or agriculture.

Put another way, the global economic system and our own post-World War II economy are unsustainable. The present architecture of international trade, and the structure of the major and minor markets that allocate resources and capital are incapable of addressing the great global challenge of the era.

Here at home, the economy is on life support and failing fast. The brilliant Cold War economic engine – designed in the period from 1944 to 1956 to provide jobs and homes to returning World War II veterans, to overcome postwar resource shortages, to disperse US industry in the event of an all-out nuclear war with the Soviet Union, and to generate sufficient resources to maintain a global military enterprise – is now working against our strategic interests.

Committing the nation to address shared global challenges has earned the United States the title “leader of the free world”. And each time, we led by reshaping our economy to do the strategic heavy lifting. In World War II, we were the “arsenal of democracy”. In the Cold War, we “contained” the Soviet Union so we could defeat them in a longer-term contest of economic and political systems.

Presidents Roosevelt, Truman and Eisenhower demobilised the wartime economy to focus on “The American Dream”, using pent-up and manufactured demand for suburban housing to absorb excess labour and industrial capacity, and to disperse the population in the event of nuclear war. To lead the transition to global sustainability, we will need to draw on the same fundamental formula – our economy must once again do the strategic heavy lifting.

Resetting the market for sustainability

If our strategic imperative is to lead the transition to global sustainability, and the means is by letting our economy do the heavy lifting, the central question is how to align the US market economy to the task. To do this, these articles will propose a set of policies under the rubric of open-market sustainability.

Open-market sustainability would establish a new economic engine for the United States, by updating three master nodes of the country’s economy trapped by Cold War-era priorities: housing and transportation, agriculture and the price of labour and resources. With these keystone sectors oriented toward the 21st century, an open-market – in which the government enforces a legal framework to ensure that the nation’s markets protect property rights, enforce contracts, and remain uncorrupted by distorting concentrations of power among buyers or sellers – will allocate resources and capital consistent with our long-term strategic requirements. Done well, decisive shifts in each of these pivotal sectors will position the US for leadership of the larger transition to global sustainability.

Ultimately, these articles seek to articulate pragmatic policy options, not to develop new economic theory. The US has great problems to solve in a very short time frame and we need to harness the economy to do the heavy lifting now. Accordingly, we must be focused on solving our great strategic challenge, by illuminating the right combination of sticks and carrots to reset the US economy for a difficult new century.

Read the second instalment of this essay here: Stop subsidies, switch to organic farming. The third and final instalment will be published here on Al Jazeera Online later this week. 

Patrick Doherty is deputy director of the National Security Studies Programme and director of the Smart Strategy Initiative at the New America Foundation.

A version of this article was first published on the Solutions Journal.