We've voted. What's next for the economy?

By Mohamed A. El-Erian
Wednesday, November 3, 2010

With the two chambers of Congress split between Democrats and Republicans, the conventional wisdom likely to be repeated over the next few weeks is that political gridlock is good for the economy. While often true, that is not the case today.

Such thinking is based on the view that political gridlock inhibits or paralyzes economically unproductive government actions. With government out of the way, it follows that the private sector can allocate capital to the most productive uses.

But this view is most applicable to a private sector that is in good shape - businesses and households with robust balance sheets, positive cash flow and access to credit. In such a world, the path of least resistance translates into higher economic growth and jobs.

Today, many large companies and rich households are in a good position to move forward. They have the means to spend and hire. Yet they lack the willingness to do either, as illustrated by massive cash holdings and widespread efforts to reduce risk in balance sheets and investment portfolios.

Many of these companies and households explain the divergence between their will and their wallet by pointing to regulatory and tax uncertainty, the absence of a clear macroeconomic vision, and the notion that the Obama administration is "anti-business." They have a point in complaining about what economists call unhelpful "regime uncertainty." Moreover, many believe that political gridlock is preferable to what they perceive as misguided government activism of the past two years. Yet this ignores a glaring reality.

For too many segments of our society, the ability to spend and hire is constrained not by questions of willingness but, rather, by stubbornly high unemployment, annihilative debts and, in some cases, concerns about losing one's home. As a whole, the United States is still overcoming the legacy of years of over-leverage and misplaced confidence that consumption can be financed by borrowing rather than earnings. The resulting debt overhangs act as strong headwinds to growth and employment generation.

This world speaks to a different characterization of private-sector activity - rather than able and willing to move forward unhindered if the government simply gets out of the way, this is a private sector that faces too many headwinds. In these circumstances, high economic growth and job creation require not only that the private sector moves forward but also that it attains critical mass, or what Larry Summers, the departing head of the National Economic Council, called "escape velocity."

While certain sectors of the economy are in control of their destinies, the private sector as a whole is not in a position to do this. It needs help to overcome the consequences of the "great age" of leverage, debt and credit entitlement, and the related surge in structural unemployment. The urgency to do so increases in the rapidly evolving global economy, as United States gives a bit more of its economic and political edge to other countries daily.

Simply put, these realities make it necessary for Washington to resist two years of gridlock and policy paralysis. Democrats and Republicans must meet in the middle to implement policies to deal with debt overhangs and structural rigidities. The economy needs political courage that transcends expediency in favor of long-term solutions on issues including housing reform, medium-term budget rules, pro-growth tax reforms, investments in physical and technological infrastructure, job retraining, greater support for education and scientific research, and better nets to protect the most vulnerable segments of society.

Success requires an element of policy experimentation as well as confidence that mid-course policy corrections will be identified and undertaken on a timely basis. And such efforts must be wrapped in an encompassing economic vision that acts as a magnet of conversion nationally, counters growing international frictions and facilitates much-needed global economic coordination.

This is not an easy list. It will be difficult to translate today's political extremes into a common vision, analysis and narrative. Yet the longer it takes to do this, the greater the effort that will be needed to restore our tradition of unmatched economic dynamism, buoyant job creation and global leadership.

The writer is chief executive and co-chief investment officer of the investment management firm Pimco and author of the 2008 book "When Markets Collide."

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