Prescription for Getting a Healthy Economy Back

While President Bush and Gov. Bill Clinton vie for the presidency, the rest of the country is battling to extricate itself from one of the slowest three-year periods of economic growth since the 1930s. What is more, instead of creating jobs, the recovery is so weak that it is causing many companies to shed workers, thereby exacerbating the economic malaise.

On top of all this, there is a feeling outside the nation’s capital that the people chosen to run this country find themselves unable to do anything to jump-start the economy. This too is a six-decade first: Not since the 1930s has Washington been so powerless.

Then, the government was too small to exert much influence over the course of economic events, even if it knew what to do--and it didn’t, since taxes were raised and the money supply shrunk, when just the opposite was called for. Today, of course, the government is big enough to influence economic activity (some would say too big, but that’s another story), and policy-makers presumably know what to do.

The problem is that the three levers that Washington uses to guide the economy have been used to their maximum and are no longer operative.

One lever, monetary policy, has been used extensively since the beginning of 1989. Then, the federal funds rate was 10%, and bank reserves were hardly growing; today, short-term interest rates are at 30-year lows, yet consumers and business continue to pay off debt. This is because both lack confidence: People are afraid of losing their jobs, while most businessmen see only dim prospects for sales. In this environment, the Fed could push interest rates down to zero without boosting borrowing.

Another lever, fiscal policy, is seemingly impotent as well. Washington’s budget deficit is so huge, the government can’t deliberately widen it by cutting taxes and/or increasing spending--two remedies that were recommended by Keynes to boost economic activity back in the 1930s, and which have been used throughout the postwar period, whenever stimulus was called for. The deficit for the government’s fiscal year that ended Sept. 30 was the biggest ever in absolute terms, and one of the largest relative to the size of the U.S. economy since just after World War II. As a consequence, Washington’s debt outstanding now is at $4.1 trillion--an amount that equals 70% of the gross national product, the most in 36 years.

The government’s inability to use its fiscal and monetary levers limits its freedom to alter the value of the dollar in foreign exchange markets. To depress the dollar, which would make our exports cheaper overseas while increasing the price of imported merchandise, the Fed would have to create more dollars--in other words, ease money further. But this is not practical for reasons discussed above.

At the same time, the already huge budget deficit necessitates that Washington sell some of its securities abroad in order to avoid congestion in our domestic markets. But overseas investors will not buy Treasury securities if the dollar is falling and dollar-denominated interest rates are low. A falling dollar reduces the value of foreigners’ holdings, while U.S. rates that are lower than elsewhere mean that they could earn more by investing in other countries.

I think that there is a way to jump-start the economy. In my opinion, we face not just the one problem of a sluggish economy, but a second problem of the burgeoning budget deficit. With this in mind, two courses of action necessary: First, deal with the more immediate and pressing problem of boosting economic growth. Second, address the longer-run issue of reducing the deficit.

Since the economy’s problems are so similar to the 1930s, the main solution should stem from that era as well. I refer specifically to the government assuming the role of employer of last resort. In the 1930s, this took the form of the Work Projects Administration, or WPA. In the 1990s, it should involve increased public investment in the nation’s roads, bridges, water and sewer systems.

Such a program would have tremendous ripple effects. First, by putting people back to work, we can simultaneously address the twin problems of lack of confidence and depressed spending. Anytime an unemployed person finds a job, that person will feel better--and will spend every dollar earned and then some, addressing deferred needs. This will start the ball rolling.

Then remember that it is the private sector that makes the steel, cement and wire cables that go into rebuilding the infrastructure, not government, and you get an additional lift. This will eventually lead to increased hiring, more confidence, income and spending, and so on. As for the money, it’s already in the budget, in the form of the transportation bill signed last year by the President but not yet widely disbursed to the states for a variety of reasons. Why not cut the red tape and get the money out?

The government could also cut Social Security taxes. This is the biggest tax that the average household pays, and right now it is draining considerable buying power from families who need it most.

Social Security has always been pay-as-you-go, so what’s the point of creating a surplus to be theoretically available for people who retire 20 years from now at the expense of holding down economic activity today?

Washington should also repeal the luxury tax. This has turned out to be far more harmful to those who build the expensive cars, private planes and yachts than to the would-be buyers. Help business overcome its lack of confidence by making it cheaper to invest in people, equipment and even physical plant by cutting the capital gains tax and restoring the investment tax credit.

These were the key provisions of the Tax Reform Act of 1986, which also hurt the real estate market, thus affecting many industries, so why not go all the way and repeal it entirely? This act has contributed to the decline in home building. It has cut into new-business formation, thereby stripping the economy of its main source of job growth. And by eliminating the deductibility of consumer interest expense, it probably caused much of the decline in new car sales the last seven years.

Longer run, the deficit must be reduced. However, serious progress toward cutting the deficit must await faster economic growth. Like a patient needing an operation, the economy must be strong enough to take the strain of deficit reduction. When it is, the only politically acceptable way to reduce the deficit would be to freeze inflation-adjustable government spending on everything except the interest it must pay on its debt, and combine this with a value-added tax excluding food, housing and medical care, a tax on imported oil, and higher taxes on alcohol and tobacco.

As long as the economy is growing, these measures will reduce and eventually eliminate Washington’s deficit over time. The deficit is so big, it’s difficult to say how long it will take to eliminate it, but my guess is at least five to seven years after the program is begun--and I wouldn’t recommend starting it until 1994 at the earliest.

Our problems are not unsolvable. They merely require the application of common sense, sacrifice--and political leadership. Surely in a country as great as ours, we can find these traits within ourselves and our leaders.