Clinton Lost Chance to Boost Economy by Not Focusing on Productivity

President Clinton missed an opportunity to strengthen the U. S. economy.

What we needed were reductions in government spending, in government programs that discourage investment and in costly regulation. What we have been offered is a mixture of McGovernite redistribution, higher taxes and more government spending. The program, if adopted, will have a negative effect on incomes, productivity and living standards.

Polls show that the initial public reaction to President Clinton’s economic program has been positive, although consumer confidence fell. The financial markets gave a negative response. Interest rates fell for about a week. Stock prices fell at first, then partly recovered but remained below the levels reached before the announcement. The dollar fell on international currency markets.

Administration officials claim to be pleased by the financial market responses. They should not be. Falling interest rates accompanied by lower stock prices are signs of a weaker economy.

The initial reaction of market professionals is that demand will be lower and that the recovery will slow because the negative effect of higher taxes will more than offset any positive effects of increased government spending. The dollar’s decline shows that currency market professionals share this view.

The fact that the stock market recovered some of its initial losses is not evidence of second thoughts. Declining interest rates lift stock prices and other asset prices even in recessions. The reason is that a dollar of earnings is worth more as interest rates decline.

If expected income and corporate earnings had been unchanged, the fall in long-term rates would have raised stock prices. The initial decline in stock prices, with interest rates falling, signaled an expected decline in corporate earnings. Whatever happens next, the first response is negative.

The difference between the public’s reaction and the market’s response is the difference between rhetoric and reality. The President talks about investment, jobs and a stronger economy. The public responds to these appeals. Market professionals put their income and wealth at risk, so they not only listen to the rhetoric, they look at the details of the program.

The details are discouraging. Massive tax increases--$283 billion, including Social Security taxes and fees, over four years--will not produce more jobs or more investment. Most of this revenue will be spent to increase redistribution and government spending. Despite the rhetoric, very little of the additional spending is for investment in capital equipment to raise productivity.

The President, and his spokesmen, abuse the language when they use the word investment. “Investment” includes spending $9 billion for food stamps, $9.5 billion for AIDS and women’s health, $2.5 billion for low-income housing, $6 billion for “national service” (forgiveness of educational loans) and $2 billion for temporary summer jobs. Then there is $2.5 billion for unemployment compensation, $3 billion for community development, $20 billion to raise the incomes of the working poor and billions of dollars more for a long list of similar programs.

These amounts are additions to the expenditures already scheduled. Some of the spending may be useful. Some will be wasteful. None of the items I listed--more than $50 billion in four years--will contribute much to the increase in knowledge, training and physical capital that is properly called investment.

There are some exceptions. A tax credit to encourage research costs $6.5 billion. Small businesses get a permanent tax credit at a cost of $12 billion. But much of the program encourages spending for consumption, or increases spending on government programs for the environment and low-cost housing. Spending of this kind may be pleasing to particular groups or the general populace. It may be useful or desirable for reasons unrelated to productivity. But it does not increase productivity.

Like the “investment” program, the short-term stimulus program to create jobs is a hodgepodge. Extending unemployment benefits does not create jobs; it slows growth of employment. Nor do additional spending on AIDS, modernization of the tax collection system or inoculation against measles--all part of President Clinton’s stimulus program. Again, some of these expenditures may be desirable (for example, I favor the extension of unemployment benefits), but spending of this kind contributes little or nothing to jobs, productivity, or living standards.

The largest single item in the President’s stimulus package is a $15-billion temporary investment tax credit. Why would anyone expect business as a whole to invest more when faced with a two-year, temporary $15-billion incentive paid for by a permanent $6-billion annual tax increase on corporation earnings? Why give a permanent investment incentive to small business but a temporary incentive to all others? At best, the temporary investment tax credit will shift investment into 1994 from 1995, when the credit expires. But it will not increase long-term investment or raise productivity.

The Administration talks about creating 500,000 new jobs. Their own numbers show that if they did nothing, the unemployment rate would fall to 6.6% in 1994 and 5.8% in 1997. With their program, they claim the unemployment rate will be 6.4% in 1994 and 5.7% in 1997, a decline of one or two tenths of a percentage point. These differences are 260,000 and 130,000 jobs in an economy that created 1.6 million jobs in 1992 and 19 million jobs in the 1980s.

The Administration’s major claim is that the budget deficit will decline. I doubt that this claim will be realized unless there are substantial, additional cuts in spending. Even using the Administration’s numbers, the reduction in the permanent, or structural, deficit is small. The structural deficit starts at $258 billion in 1993 and falls to $201 billion in 1997, a decline of $57 billion in four years. Without their program, the Clinton Administration claims, the structural deficit would have increased to $341 billion, so they claim a reduction of $140 billion.

They will not realize most of what they claim.

Higher taxes will slow the economy; higher government spending will both shift resources toward consumption and increase subsidies for favored projects. Savings in government programs will be smaller than predicted. Congress has rejected the proposed cuts in the growth of spending many times.

Already, the tax-exempt bond market is booming. And the Clinton program brings back tax incentives--soon to be called loopholes-- forholes investment in low-income housing and certain mortgages. No doubt other favored projects will follow.

This is only the beginning. More taxes for health care are on the drafting table. Is this the change 43% of the voters wanted? To me, it seems a missed opportunity to build on the stronger productivity growth we are now seeing, to build not just jobs but rising incomes and higher standards of living. A pity that President Clinton booted the opportunity.