January 2008

The 2008 State of the Union: Addressing Key Questions of Foreign and Economic Policy

On Monday, January 28, 2008, AEI hosted a public event to mark the president's State of the Union address. As President Bush enters his final year in office, many have begun to debate his administration's legacy. In his eighth and final State of the Union address, issues of foreign and fiscal policy are sure to be central to the president's address to Congress.

It has been more than six years since the terror attacks on New York and Washington. Has the United States made progress in the war on terror? Certainly, the last year has brought good news in Iraq as a result of the surge. But now Afghanistan looks to be in serious trouble, and U.S. casualties are rising. And what of the "Freedom Agenda"? Is it, as so many suggest, dead? Democracy is in retreat in Russia and not on the horizon for China. Will this president's legacy be status quo ante in much of the world?

The nexus of an election year and a struggling economy will surely bring economic policy to the forefront of the policy agenda. The economic panel touched on a number of pressing issues, including the forthcoming economic stimulus package, instability in the housing market, rising oil prices, and the future of American trade policy. How will the president's agenda be shaped by the 2008 elections? Can Congress reach effective solutions to the nation's economic challenges?

These and other questions were the subject of two panel discussions led by AEI's vice president for foreign and defense policy studies, Danielle Pletka, and by AEI's director of economic policy studies, Kevin A. Hassett.

Panel 1--Foreign Policy

Michael Rubin
AEI

Some of the major issues that the president may address are the ongoing situation with Iran, the Arab-Israeli conflict, and the democracy and dissident issue. The president will probably reaffirm his commitment to preventing Iran from gaining nuclear weapons or fissile material, which would be ironic in the face of fuel shipments from Russia arriving in Iran earlier this week. Since taking on the Axis of Evil, the president has only won in one of the three confrontations. There have been major shakeups in the process following the National Intelligence Estimate (NIE) and the Government Accountability Office (GAO) report on sanctions, but there has been little commentary on their direct contradictions--the NIE suggests that pressure and sanctions can work, while the GAO report says they cannot. Containment is a military strategy that requires the United States to give assistance to its regional allies, have forces in the region, and upgrade bases in the region in order to be effective. The president's remarks in this area may be too heavy on rhetoric and too light on substance.

The Arab-Israeli conflict is becoming a legacy issue for the administration. However, beyond the Annapolis photo opportunity, the only agreement that the administration has achieved--the Philadelphia Corridor between Egypt and Gaza--has collapsed in the last week. If President Bush cannot follow up on the agreements he has brokered and cannot make cautious and considered ones, he should be careful about what rhetoric he uses.

Democracy and dissidence is the so-called heart of Bush Doctrine, but it will probably be absent from the speech. Fathi el-Jahmi, a Libyan dissident previously endorsed by Bush, appears to be dying. The president will often make high-minded declarations about the importance of democracy and dissent--in a speech in Prague in June 2007, he made promises to a number of dissidents, but none of these promises appear to have been fulfilled or even acted upon. The question is whether this has been because of mismanagement by the bureaucracy beneath the president or if it is a tool used by the administration to win the short-term silence of some policymakers.

Leon Aron
AEI

The president will probably not talk about Russia at all, which is unfortunate. There have been three troubling developments in Russia of late. First, there is an increasing probability of domestic, political, economic, and social instability. Second, Russian foreign policy is designed to bolster a Soviet-style image of a besieged fortress under threat from the West. And third, Russian foreign policy has undergone ideologically motivated changes resulting in an anti-West and, more specifically, anti-United States sentiment, and this may lead to complications in the future.

It would be hard to claim that Vladimir Putin has bequeathed stability to Russia. In the 1990s, Russia had messy but increasingly democratic government institutions. Today, Putin has undermined all of the legitimizing and stabilizing institutions needed in a functional democratic state: an independent and powerful parliament, a party system, an independent and trusted judiciary, an honest media, and local self-rule. The sole legitimizing institution now is Putin's popularity, which hinges on the continuing growth of the economy and job market, which in turn depends on the price of oil. The regime has to cope with growing inflation, a possible reduction in oil revenue, the confusion and division of power between president Dmitry Medvedev and regent Putin, and the potential lack of acceptance of Medvedev by powerful clans in the Kremlin. Vital infrastructural reforms have been abandoned in economics, housing, and education. A labor crisis is looming because of extremely high mortality. The pension system is broke, corruption is rampant and the military is dysfunctional.

In foreign policy, Russia has shifted from exploiting existing crises to creating or stoking them. For example, through the current conflict with Iran, Russia is attempting to recover the former Soviet position in the Middle East, keep the oil price as high as it is now or boost it higher, and prevent Iran from getting nuclear weapons. Russia has opposed United Nationa (UN) sanctions on Iran, which may allow Iran to get nuclear weapons and provoke a military crisis, keeping the price for oil high. The United States and Israel will inevitably take care of a nuclear-armed Iran, allowing Russia to keep oil prices high and reclaim a position similar to the one the Soviet Union held following the Yom Kippur War in 1973.

Dan Blumenthal
AEI

President Bush will probably not mention Asia at all, unless he refers to the success in talks with North Korea. It is both a shame and a danger that Asia is not being talked about. There is the potential for a major conflict to break out between Taiwan and North Korea over the Taiwan Strait. In the beginning, the Bush administration laid the groundwork for working against Chinese military expansion and North Korean nuclear aspirations. Extensive work was done with Japan under Junichiro Koizumi, but that alliance is now bogged down negotiating real-estate issues in Okinawa. The United States has returned to the Sinocentric policy of the 1980s despite the United States and China sharing so very few interests.

The United States has yet to deal with the largest post-Cold War military buildup in the world, which can only be explained by a Chinese desire to reorder Asian international politics. The Taiwan issue is a major flashpoint for a future great power war. It may be emotionally gratifying to chide Taiwan for an inflammatory separatist policy and stop our arms sales, but this ultimately hurts our interests in the region. On the North Korea issue, our policy to disarm North Korea is not working--it is clear that the next administration will have to deal with nuclear-armed North Korea. There is currently no reason for North Korea to take U.S. threats seriously, and therefore there is no incentive for North Korea to abide by its agreements. And a lot of work is necessary to repair the U.S.-Japanese relationship.

Thomas Donnelly
AEI

The president will undoubtedly talk about the war in the speech in some form. On the Iraq front, the president has a lot to be proud of. The surge has been broadly accepted as a successful move, but it is currently incomplete. There have been important political benchmarks: al Qaeda in Iraq has been as successfully defeated as it is possible to do. We can also see the conditions for broader political progress forming. The local political process is working upward and affecting the situation in Baghdad. It will be important to prepare for the election transition, particularly if there is a party change. Keeping General David Petraeus in command is key to retaining some continuity in Iraq across the election transition. Another question will be the future troop levels in Iraq--scaling back on the surge involves the eventual removal of five brigades. Keeping anything below fifteen brigades in Iraq will not work, as U.S. troops will need to be dispersed to effectively continue the fight. Our UN mandate expires in a few months, and anti-war opposition in Congress is working to prevent a status of forces agreement that would commit the United States to long-term strategic partnership with Iraq.

Increasing attention is being paid to Afghanistan. It will be a challenge to conduct parliamentary and presidential elections in 2009 right after the change of U.S. administrations. In order to succeed in Afghanistan, the south is crucial--the Taliban is reviving in this region, and NATO forces need help. There is also the underlying question of how to treat the NATO alliance in Afghanistan in the future. The domestic perception is that the continued fighting in Afghanistan is about al Qaeda. However, the main al Qaeda presence is now in Pakistan, not Afghanistan. Benazir Bhutto's assassination may be mentioned, but there will probably be no significant change in the U.S. policy focus on Pakistan. A compounding problem is that the Pakistan army is one of the biggest problems but is also our only viable option for stability.

There are obviously large differences between where the United States was in 2000 and where it is now. This has really been the first post-Cold War presidency, and power politics has come back powerfully all across the planet. The failure of the president's freedom agenda is not striking, as the policy community does not respond to it positively. However, the fact that it exists at all is major.

Panel 2--Economic Policy

Kevin A. Hassett
AEI

The extent of the current international economic crisis is unknown. In his final State of the Union address, President Bush faces an interesting conflict because he cannot boast of a strong economic legacy. Instead, his predicament is convincing the American public that the economy is stable but weak enough to still need the economic stimulus package.

There are two potential scenarios for the economy in 2008--both equally likely. In the first scenario, Business Fixed Investment will decline, leading to a full-fledged recession. In the second scenario, no recession will occur. There are two significant aspects to the current stimulus package. The first consists of an individual tax refund that will most likely be delivered in April, May, or June. Unfortunately, these tax refunds do not have a good history. The second aspect of the stimulus package refers to the Investment Tax Credit. Investment Tax Credits have provided significant stimulus to investment in the past.

In addition to discussing the stimulus package, President Bush might call for the renewal of the No Child Left Behind Act in order to preserve some type of legacy. Bush's speech, however, will be unique in that more emphasis will be placed on the short-term challenges that our economy faces instead of his long-term legacy.

Philip I. Levy
AEI

Recently, there has been a sharp disagreement on trade policy between the administration and the Democratic Congress, especially regarding labor and environmental issues. Currently, there are the United States has pending trade agreements with Peru, Colombia, Panama, and South Korea. These trade agreements are "cross-over issues" because in addition to their economic importance they also have strong foreign policy implications for their respective regions.

The general debate about these trade agreements is often misconstrued. While the administration has repeatedly emphasized the importance of the trade agreements to the U.S. economy, all four of these countries have relatively small economies in comparison to the U.S. economy. Congress has argued that these agreements hurt U.S. workers, which is generally untrue. The Doha Round negotiations differ from the other trade agreements in that they are not completely under U.S. control. President Bush will likely ask congress for Trade Promotion Authority so that the administration can regain credibility in negotiating trade agreements. Additionally, Bush will probably raise the issue of agricultural policy reform.

The U.S. economy is deeply engaged in the global economy. Recently, however, many have questioned U.S. commitment to foreign markets. President Bush will likely assert that the United States remains firmly committed to open trade with few exceptions, which are narrow and transparent and mostly issues of national security.

Vincent R. Reinhart
AEI

Given the current state of the country, Bush could open his last State of the Union address by repeating his first address: the nation is at war, the economy is facing recession, and the civilized world faces unprecedented challenges.

As a nation, we are certainly less wealthy than we were one year ago. Overbuilding and a global selloff of equities have had many domestic consequences. The appropriate government response is to lower interest rates as a way of rebuilding wealth. This is the role of monetary policy, although there is a lag in its effect. Fiscal stimulus can complement this role, but it must be disciplined. There is significant work to be done regarding the U.S. tax system. Social Security and Medicare must also be addressed because these issues will only continue to worsen as the population ages. President Bush is likely to propose strategies for protecting our national economy in an uncertain world. The U.S. economy is resilient because of the strong reactions generated by incentives. The international trading system should be strengthened, and although protectionists argue that increased trade often hurts the United States, open markets will always benefit the U.S. economy.

Many of these issues cannot be settled by a lame duck administration with a hostile Congress. Instead, President Bush will mention these issues in order to set a new direction for the country.

Peter J. Wallison
AEI

The two issues President Bush will mention during his State of the Union address will be the economic stimulus package and the current housing mess. This is remarkable for a president's last State of the Union address because presidents usually emphasize long-term effects of their time in office. Instead, Bush will address short-term challenges that have potentially adverse long-term effects.

With the stimulus package, Congress and the administration have adopted a "do something--anything" approach. In enacting this economic stimulus policy, there is a risk of moral hazard and setting a precedent for fiscal action in similar future events. This stimulus package will include two types of tax cuts: individual and business. There are two problems with this policy. First, the refundable tax credits are not tax cuts but rather deficit spending. Second, short-term tax cuts do not promote long-term growth. The business tax cuts, however, will have a significant effect in growth, specifically in creating jobs. Treasury Secretary Henry Paulson has said that this move is insurance against a recession; if it is insurance, it is expensive insurance. The Fed's interest rate cut will have some inflationary effects. The tax cuts will further weaken the dollar; this administered decline in the dollar raises the question of whether the dollar should be the international reserve currency. Other countries are affected by this domestic policy, which is worrisome.

Currently, there is need for government sponsored enterprise reform. Although there was recently a promise to attempt reform, this is neither significant nor sufficient. Reform is important because of the recent raising of the conforming loan limit. The significant increase in the conforming loan limit puts taxpayers at increasing risk for more expensive mortgages.

AEI interns Kevin Hudnell and Sarah Kunkle prepared this summary.