Next President Has Work Cut Out

As we approach the November election, voters will increasingly assess the state of, and prospects for, the economy. They will compare the economic policies and programs proposed by Vice President George Bush and Gov. Michael S. Dukakis as important factors in determining their votes. Hence, an objective look at the relative economic performance of the Reagan-Bush years compared to the trends they inherited and with performance elsewhere in the world for the same period should be enlightening.

The economy is in the 67th month of the longest postwar peacetime expansion. Real gross national product grew at an annualized rate of 3.9% in the first quarter of 1988, a robust performance. From 1980 to 1987, real GNP grew by 20%. The unemployment rate, which averaged 6.2% in 1987, is now fluctuating around 5.5%, a level we have not averaged for a whole year since 1974. Consumer prices are up 4% relative to a year ago; in 1979, they rose 13.3%, and in 1980, 12.2%. The average inflation rate for President Jimmy Carter’s four years, 1977-80, was 10.4%. For the seven years 1981-87, it has been 4.3%.

Arthur Okun, former chairman of President Johnson’s Council of Economic Advisers, coined the phrase “Misery Index,” the sum of the inflation and unemployment rates. The “Misery Index” is now at a 20-year low.

Federal taxes as a share of GNP are a little over 19%, almost exactly what they were in 1979-80, and a little higher than the average for the 1970s. The tax policies of the 1980s did not cut federal taxes as a share of GNP; rather they prevented large increases in the share of taxes in GNP from occurring. Had the pre-1981 policies continued in effect, taxes would have soared to 23% of GNP by 1985.

The U.S. economy has continued its impressive job creation. Employment has grown by about 14 million since 1980 at a time when there has been absolutely no new net job creation in the advanced economies of Western Europe. The reduction in inflation, the lengthy recovery, the tremendous growth in employment and the low unemployment have been accompanied by an unprecedented creation of wealth. As of this writing, the Dow Jones industrial average is above 2,100, about 20% higher than two years ago, although well below the elevated levels of last year. The Dow was in the 770s in 1982. Despite the fall in stock market in late 1987, its level now is almost triple what it was in 1982.

Simultaneously, interest rates have fallen substantially. Those on new FHA-financed home mortgages fell from 12.7% in 1980 and 14.7% in 1981 to 9.3% in 1987, extending the dream of home ownership to millions of Americans who would have been priced out of the market at those higher rates.

The strong rebound of the manufacturing sector and of exports are a continued source of strength to the economy. These sectors were heavily damaged in the early 1980s by the overvalued dollar but have now made a tremendous turnaround. This achievement by American workers and management in these sectors of the economy bodes well for the continued improvement of our trade balance for the next several years. As of mid-June exports were up 29% from a year ago and in 1987 the United States regained its role as the world’s largest exporter. Over the last year, steel production is up 17%, auto and truck production up 13%, coal production up 19%, lumber production up 15% and paper production up 8%.

What does all this mean for the typical American family? Adjusted for inflation, median family income (half the families have incomes above this amount and half below) increased by 9.1%, or about $2,500, from 1981-86 (and has since risen further). From 1977-80, it fell by 3.5%, or a little over $1,000. Thus, if the 1977-80 trend had continued, instead of increasing $2,500, median family would have fallen $2,000 to $3,000. Hence, between the Reagan-Bush improvement and the projection of continued deterioration of the Carter years, there was a gain of about $5,000 for the median family.

So much for the average family. What about the poor, minorities and women? In 1987, the unemployment rate for adult females was 5.4%, the same as for adult males. Before the Reagan-Bush era, the female unemployment rate exceeded the male unemployment rate every year except one--1958--when they were the same.

In 1986, the overall poverty rate was 10.9% versus the 11.2% when Ronald Reagan assumed office in 1981. The rate rose under President Carter (I do not mean to imply that it was all his fault) from 9.3% to 11.2% by 1981. In the 1981-86 period (since then, further improvements have occurred), the poverty rate for blacks--which is much higher than that of whites--fell by 2.8 percentage points, while it fell by 0.2 percentage points for whites.

From the recession of 1982 to the end of 1987, the average annual percentage increase in employment has been 2.7% for all workers, 3.3% for females, 4.7% for blacks and 6.8% for Latinos. Although minorities still lag behind, this is substantial testimony that a robust expanding economy is the best way to assist low income and minority workers and families.

What about inflation? Cumulative consumer price inflation for the four years 1977-80 was 41.5%, averaging 10.4% a year. For the seven years 1981-87, it totaled 29.9% averaging 4.3% a year and has been relatively stable for several years (although it is up slightly this year, primarily due to the pass-through of rising import prices from the fall in the dollar’s value). If we confine ourselves just to food, from 1977-80 the average annual increase was 10%; from 1981-87, it was 3.4%.

The median family had an income around $29,000. It spent about $5,000 a year on food, or about $100 per week. If the Carter inflation had continued, that food basket now would cost $154, or $2,800 more per year. Of course, wages might have kept up with this higher inflation rate but, even if that had occurred, this family would have paid substantially more in taxes, given that the tax system in place in 1980 was “not indexed” for inflation.

That is the good news. The bad news has been our federal budget deficits soaring to unprecedented levels during a period of peacetime prosperity, with the national debt more than doubling, and our large and growing external debt.

What caused the budget deficits? As noted above, taxes are now 19% of GNP, precisely what they were during the last two years of the Carter Administration. Government spending, however, has risen to 22% to 23% of GNP, causing deficits of $150 billion per year.

Recall that Congress is responsible for spending and tax decisions. The President proposes and (potentially) vetoes what Congress legislates. The defense buildup of the first Reagan term has given way to four consecutive years of no real defense growth and various other attempts to reduce the budget deficit with small additional revenues and cost savings elsewhere in the budget.

The major task facing the next Administration and Congress is to get the budget deficit under control without throwing us into a recession. My view is that the substantial tax increases that have been expressly suggested by some (especially House Democrats) and implied in the statements of Gov. Dukakis could cause a recession on the one hand, and are very unlikely to work their way fully into deficit reduction, on the other.

Surely, some of any tax increase will be spent. A key task of the next President will be to keep Congress’ appetite for ever-larger spending programs under control. The President does not have a constitutional amendment binding Congress to a balanced budget, unlike most state legislatures, including that of Dukakis’ Massachusetts.

If we resort to substantial increases in taxes, new spending programs, a new round of stifling regulation, mandated private activity and accelerating inflation, the successes of the last seven years will go down as but a blip on the road toward European-style social-welfare statism. Our economy will lose much of its flexibility, dynamism and vitality. That would be tragic, as the moribund, slowly growing, high-unemployment economies of Western Europe attest.