Memo to: President-elect Clinton
From: Chairman, Council of Economic Advisors
Re: Fixing the economy
The foremost challenge for the United States, as you said often and eloquently on the campaign trail, is to start investing in our future again. Without investment and growth, the economy cannot produce good jobs, supply resources for cleaning up the environment, or provide young and old with the economic security they need and deserve. And without a strong economy, we cannot hope to lead an international order in which technological competitiveness and economic vigor count for more than MX missiles and Seawolf submarines.
Investing more for the future means consuming less in the here and now – an unpopular truism that helps give economics its reputation as “the dismal science.” A lot of presidents before you ducked that reality, buying short-term prosperity and popularity at the expense of the nation’s long-term economic health. Fixing their mistakes won’t be politically possible unless you instill in the American people a collective purpose and willingness to sacrifice. People will rise to this challenge only if they sense their sacrifices will be shared fairly and if the federal government itself sets an example of fiscal responsibility. If idealism and energy are untempered by prudence and accountability, the public may rightly come to regard all your talk of “investment” as just another excuse for reckless spending.
The pundits have noted in your personality a deep desire to please; as president you must learn to displease. A responsible economic policy will disappoint a lot of powerful interest groups, including many in our own party, who expect money to start flowing their way now that you occupy the White House. Take Nancy Reagan’s advice and “just say no” to them. Instead of spending more – the federal government already lays out well over $1 trillion each year – we need to spend smarter. This argument isn’t just an excuse for stinginess. Better targeting of funds will earn the public’s trust and produce greater results.
Good policy often dictates restraint when grand programs would be politically expedient but economically counterproductive. You will hear otherwise from some of your advisers who enjoy the taste of power. A lot of the experts fluttering around your bright bulb have been out in the cold since 1980 and now see a chance to test all the schemes they have been dreaming up in their think tanks and academic offices. Weigh their nostrums skeptically; it’s easier to mess up an economy than to make it run smoothly.
GETTING US OUT OF THE RECESSION
Our immediate challenge is to revive an economy that has left more than nine million people unemployed. Unlike President Bush, you know the pain out there is real. But as agonizing as the slow recovery has been, we must avoid sowing the seeds of further recession or stagnation by overreacting. Some big traps await us. If we go on a spending binge, as many liberal economists of Keynesian persuasion demand, the money may not work its way through Congress and into people’s pockets until after the now- feeble recovery has picked up, thus fueling inflation. Alternatively, financial markets may panic and send interest rates soaring, canceling many potential gains and leaving us with little to show but a bigger deficit. It may seem unfair that the markets hold us captive, but that’s reality.
Rather than pushing the deficit further into the stratosphere, you should arrange a quiet lunch with Alan Greenspan in his private dining chamber at the Federal Reserve Board (the security there is better than at the CIA) and tell him straight: The only way the Clinton administration can hold the line on new spending is if he gives the economy the monetary kick it needs. Wall Street trusts him, so the markets won’t go ballistic when he comes through with lower interest rates. And you will be seen as a statesman on fiscal policy.
INVESTING IN AMERICA
Our bigger economic challenge is to reverse the economy’s long-term decline. This problem didn’t start with George Bush. From 1973 to 1990, before the Bush recession, real earnings grew at the nearly imperceptible rate of 0.5 percent a year. When the pie grows this slowly, some people get smaller pieces and others become less willing to share. Progressive politics will never thrive in this country unless, as in the 1960s, resources are plentiful and expanding. Though some on the left are prone to forget this, economic growth is still the best antidote to poverty.
In addition to technological innovation, the force driving growth is investment – the accumulation of both physical capital, including machines and office buildings, and what economists call “human capital,” or knowledge and skills. The great economic slowdown since the early 1970s traces directly to a tremendous falloff in both kinds of investment. The growth in the amount of physical capital per worker has dropped to less than one-fourth its rate between 1948 and 1973. And if plummeting test scores are any indication, “human capital” grew slowly in the 1970s and early 1980s as well.
Any investment must be financed by saving – preferably from domestic sources, lest the rewards flow overseas. Raising the nation’s rate of saving must therefore be our top priority. Unfortunately, saving is in desperately short supply. The ratio of national saving (government plus private) to national product fell from an average of 8 percent in the 1950s, 1960s, and 1970s to a meager 2.5 percent in the 1980s. Without higher savings and investment, machines will grow rustier, schools will decay still further, and laboratories will develop a case of technological Alzheimer’s.
Policymakers have toyed with all manner of schemes, from IRAs to investment tax credits, to remind Americans of Ben Franklin’s homilies about thrift. Nothing has worked well. Despite tax changes in the early 1980s to favor private saving, and despite record-high rates of return, the rate of saving fell.
Is it hopeless, then? Not at all. Government saving can fill the void if we slash the federal budget deficit. Deficits are a form of dissaving. Reining in the Treasury’s insatiable borrowing would free vast sums of capital for investment in factories, farms, mines, and offices.
Deficits are an insidious, slow-working poison, addictive because they let people consume more right now at the expense of a future they are too myopic to foresee. Without bold action, the deficit is liable to reach $500 billion by the year 2002, according to projections by the Congressional Budget Office. “Deficits of these magnitudes cripple economic growth by reducing national saving and capital formation,” the CBO observed recently “They also create a vicious cycle of more federal borrowing and higher debt service costs, which in turn make it still more difficult to reduce the deficit.”
Contrary to your glib campaign claims, we aren’t going to grow our way out of the deficit. (Ronald Reagan promised that, too.) It will take real leadership to make the public finally see that it cannot expect both lower taxes and greater services. The process will be slow and painful, unless Ross Perot lets us in on the secret behind his boast that he could “fix that [deficit in five minutes.” We’ll be lucky to do it in five years. At least Ross Perot had a detailed list of speedy cuts and tax hikes. As you make your own list, remember that those two sides of deficit reduction are not created equal.
Increasing tax rates will punish work and investment, potentially reducing the nation’s standard of living. Economists call this the “excess burden” of taxation. According to recent calculations by Harvard economist Dale Jorgenson and Yonsei University’s Kun-Young Yun, every extra dollar of taxes raised robs the economy of 39 cents that people otherwise would have produced.
The Republicans would like nothing better than for us to raise taxes, so they can pin the “tax and spend” label on the Democrats once again. We shouldn’t shy away from some tax increases, as I suggest later on. But let’s steal the Republicans’ thunder, and perhaps even garner their votes, by surprising them with a menu of spending cuts. If it took a cold-warrior like Richard Nixon to open the door to China, perhaps it will take a liberal like you to rein in the budget.
Anyone who can’t find some worthless items in the current budget doesn’t deserve to occupy the White House. Here are a few items from my hit list to accompany the military cuts you have already promised, along with their five-year savings:
- Cancel Dan Quayle’s pet space station (which scientists condemn with rare unanimity); $10 billion.
- Defer the Superconducting Super Collider, a worthy but bloated example of Big Science; $3 billion.
- End grain subsidies to China and other farm-export “enhancement” programs; $3 billion.
- Lower other farm payments, most of which go to families or corporations with huge assets; $13 billion (along with screams from Bob Dole and Tom Harkin).
- De-escalate the war on drugs while diverting some funds now spent on useless interdiction programs to treatment programs; several billion dollars a year.
- Slash cut-rate lending by the Rural Electrification Administration, a New Deal dinosaur that refuses to die; $600 million.
- Sell the National Helium Reserve, which we’ve held in case we ever need to build a new fleet of dirigibles; $700 million.
The list goes on and on.
TAXING THE RICH WISELY
No matter how much we cut, we’ll have to make the American people pay the real price of the services they demand. Raising tax rates on the rich, as you proposed in the campaign, is good populism but bad economics. Higher rates simply encourage the wealthy to shelter income from the IRS rather than to invest it productively. Harvard’s Jorgenson estimates that every additional dollar raised from individual income taxes costs the economy about 50 cents in lost output. That’s a bad deal, even for progressives.
This doesn’t mean we have to let the rich off the hook. Instead let’s go after the special deductions they now enjoy, which make the economy less, not more, efficient. Making the rich (those earning over $130,000 a year) pay Medicare payroll taxes on all their earned income would net $28 billion over five years. Barring interest deductions on mortgages greater than $300,000 would raise $15 billion over five years from about 800,000 owners of luxury homes. Cutting the entertainment tax deduction to 50 percent would raise another $16 billion over a five-year period.
Don’t waste all of your energy on fine-tuning the tax code, lest you open the door to special interests that will seize the occasion to fill the tax system with new loopholes. Sometimes an imperfect system that remains relatively stable is better for the economy than one that gets, “reformed” every few years, making long-run investment and tax planning impossible.
LAYING OFF THE PORK
Let’s say that we raise a lot of money by cutting fat and boosting some taxes – what then? The temptation will be to spend it all on worthy projects. After all, politicians get more credit for cutting ribbons at grand openings than for abstractions like deficit reduction.
In our own party, for example, a lot of industrial-policy advocates are clamoring for the government to help defense industries convert to advanced civilian technologies, like bullet trains. They have short memories. The kind of corporate culture that makes $700 toilet seats to exacting Pentagon specifications isn’t likely to succeed in the fluid civilian marketplace. Nor is any of us in politics and government likely to pick the right winners, anyway. We should let defense firms concentrate on their core business and let other companies, including start-up ventures, absorb the great human talent set free by our down-sizing of defense.
Beyond the military sector, you have been rallying the country to pump more public money into “infrastructure.” Before the concrete-and- asphalt lobby coined that term, critics used to call it pork. Repairing pot-holes and unsafe bridges is all to the good. But why do so many people imagine that the economy will be magically revived by massive government spending on public works?
If a careful benefit-cost analysis of a proposed new road, train system, or port looks positive, by all means let’s invest in it. But since most projects have local or regional significance only, they ought not to concern us at the federal level. If they are so worthy, let local and state governments finance them through bond issues and user fees. if people were to pay the true cost of the services they demand – for example, if owners of heavy trucks paid for all the wear and tear they put on the roads – they would use public facilities more wisely. When the federal government pays instead, lavish infrastructure spending simply becomes a money machine for pork-barrel projects that local governments can’t justify.
Let’s also make better use of the infrastructure we have through market reforms. We let prices adjust according to supply and demand at different times and seasons for vegetables, airline tickets, telephone calls, and movie matinees – so why not for roads and runways? They become congested because no one pays a price for jamming them during hours of peak use. We could ease congestion, extend the life of facilities, and finance improved infrastructure where needed by making rush-hour drivers pay tolls that reflect the true social cost of their traffic. Before spending vast new sums on more concrete and asphalt, let’s embrace a little of the conservation ethic that Al Gore preaches so fervently.
The federal government has a more ligitimate role to play in fostering a highly educated work force. Job training and educational reform are the true equal-opportunity programs. Antidiscrimination laws alone will not bring minorities into the American mainstream, nor will welfare uplift the poor, if they lack the skills to compete in a complex economy.
Education starts at the preschool level. I expect that Hillary will take the lead in championing a long-overdue expansion of Head Start, which now reaches only a fraction of eligible children. As Rutgers University economist W Steven Barnett observes, “the nation could obtain enough money to provide top-quality full-day Head Start programs to every poor child – just by eliminating agricultural subsidies to millionaires.”
There are two dirty little secrets that proponents of the program rarely mention. One is that kids who pass through Head Start retain few of its benefits in later years. Higher-quality, more-intensive programs can achieve much more – for a price. That’s a price we should be willing to pay in order to lower school dropout rates, better prepare workers for the labor force, and cut crime.
The other secret is that we know little about which methods work best in pre-school, how to sustain the gains over time, and at which age to start children on the program. Owing to the government’s failure to fund good long-term studies, “we are out there dancing in the dark on Head Start,” Barnett says. Let’s invest some serious money in finding the answers – for the sake of both kids and taxpayers.
K-12 schools represent the country’s educational Achilles’ heel, as we all know from international test comparisons. The problem isn’t just money, despite what the National Education Association maintains. The United States spends a higher percentage of its national income on education than Japan does. From 1963 to 1983, real spending per pupil leaped 70 percent, yet SAT scores dropped 34 points in math and 53 points on the verbal test. As economists Sar Levitan and Frank Gallo at George Washington University observe, “poor test performance persuasively suggests that Americans are not getting their money’s worth” from the current system.
Without serious reforms, including some sort of school choice and school accountability, more money will go down the drain. Sure, we need to pay some teachers more, but only if the unions will let schools fire incompetent teachers and pay premiums for teaching skills in short supply, such as in math and science.
One key problem is that teachers and parents expect too little of kids, so students expect too little of themselves. The average amount of time that high-school seniors spent on homework each week fell from nine hours in 1960 to four hours in 1990. According to Cornell University’s John Bishop, the problem is a lack of incentives. High- school students need only a diploma, not real proof of competence, to get into a non-elite university or to land an entry-level job. National or state achievement tests, such as you have already proposed, would motivate high-school pupils to learn more by giving colleges and employers a standard by which to gauge student performance. Similarly, federal student loans and grants would reward students who work hard if these loans we’re targeted to performance as well as to need. Such reforms don’t have to cost much to improve the quality of education.
When kids graduate from high school, they often need more preparation for work. Your plan for a 1.5 percent payroll tax on employers to fund on-the-job training may be a little too bold, however. Put it on hold for further study. In addition to its cost, it promises to be an administrative nightmare: what will count as training and who will certify that companies stick to the guidelines? For many employers, it doesn’t make sense to train workers who will soon pick up and leave for another firm. Given the mobility of the nation’s work force, employees themselves should invest in skills through community colleges and job-training sites. Federal dollars can help keep these existing institutions strong without creating a massive new bureaucracy.
At the same time, as with preschool education, federal dollars should finance better studies of what works and what doesn’t in job training. One great scandal has been the failure to learn from decades of experience about how best to prepare inner-city youth, welfare mothers, and ordinary high-school graduates for work. As Princeton economist Orley Ashenfelter noted a few years ago, “Despite nearly twenty years of continuous federal involvement, we still have to do a good deal of guesswork about what will work and for whom.” Let’s find some answers before you leave office.
Effective job training isn’t only a smart investment in productivity: it’s a prerequisite for reviving the traditional bipartisan coalition, once proudly led by the Democratic party, in favor of freer trade. The calls for protectionism that sound so loudly from Congress, the labor and environmental movements, and many industries reflect a sad loss of confidence in the nation’s ability to meet foreign competitiveness. Shrinking from challenges by closing our doors will not make them go away; rather, we must meet them by offering to retrain workers in new and higher skills as demand shifts away from older industries.
We need not fear that low-wage nations will put U.S. workers on the breadlines. If cheap labor were enough to ensure a nation’s competitiveness, Haiti and Bangladesh would be the world’s export superpowers. Trade theory and practice tell us that low-wage nations tend to specialize in producing labor-intensive goods, like footwear and textiles, while buying more sophisticated goods, like computers and aircraft, from us. Surging Mexican demand for such U.S. products has produced thousands of desirable jobs here in the last few years – and could produce many more with freer trade. We will court disaster if we raise tariff barriers anew in the name of “fair” trade.
This list is hardly all-inclusive. Down the road we must review anticompetitive regulations, such as controls on intrastate trucking, that drive up consumer costs without protecting health or safety. (Lest the word “deregulation” stick in your throat, remember that Jimmy Carter and Ted Kennedy were great champions of thoughtful market deregulation, not to be confused with the industry-coddling that gave deregulation a bad name under Reagan.)
A little humility is now in order. Even if you do manage to achieve everything on this list, you won’t change the world much. You can’t order up growth and prosperity with a snap of your fingers – or socialism would long ago have triumphed. But if you create the conditions for growth, if you advance a progressive agenda that puts the quality of the government’s effort ahead of the quantity of the government’s spending, your idealism can become a new realism, which will let the pie grow big enough to nourish all Americans.
Jonathan Marshall is economics editor of the San Francisco Chronicle.