Halting the Fall

Last week’s surprise interest rate cuts by the Federal Reserve and President-elect George W. Bush’s downbeat economic summit underscored post-boom America’s potentially steep downside. Yet, much like the end of the 1980s bubble economy, a slowdown will more likely affect the same Northeastern and West Coast urban areas that suffered the most during the 1990-92 recession. Given that his support is overwhelmingly drawn from other, more economically vibrant regions, Bush’s most savvy option may be to do as little as possible about a looming recession until it has discliplined those areas most opposed to his politics.

Since the 1980s, the United States has been split among faster-growing states that encourage relatively well-balanced economies--Texas, Arizona and Georgia--and states--New York and California--that bet far more heavily on service-sector, white-collar professional development. When financial bubbles pop, the least-diversified communities disproportionately suffer.

Just five slow-growth states--California, New York, Connecticut, New Jersey and Massachusetts--accounted for nearly 70% of the nation’s total job losses in last decade’s recession. In contrast, during the same period, employment growth slowed but never actually fell in 24 fast-growing states. Take away the Northeast and California, and the 1990-91 recession never occurred.

The “new economy” boom amplified the gap between the nation’s slow- and fast-growth states. Rather than learn from their setbacks in the last recession and diversify their economies, slow-growth states were seduced by get-rich-quick, Information Age hype. From Manhattan to the San Francisco Bay Area, once-troubled urban areas tailored their zoning, labor, land-use and business-development policies to almost exclusively foster dot-com millionaires and a virtual economy.

As long as rising stock values boosted high-end individual wealth, this strategy seemed a smashing success. Tax revenues soared, and unionized public employment expanded, masking blue-collar declines in the private sector. Politically influential developers celebrated soaring upscale-urban real estate values. Post-material urban NIMBY (not in my backyard) groups indulged their fantasy that they could live in coffee-shop opulence without having to experience such distasteful activities as actually making things or generating the power they used. New York declared itself the City of the Decade. A dot-com bookseller was named Time magazine’s Person of the Year.

The stage was set for a reprise of the 1990s recession. Once again, financial speculation grossly inflated living and business costs in the nation’s least-diversified, slowest-growing communities. Such areas are now especially ripe for a painful setback.

President George Bush’s inability to deal with the country’s regional reactions to recessions helped pave the way for Bill Clinton’s election in 1992. The former president understood that the economy was not as bad as his opponent claimed, but he failed to distinguish the few troubled states from the rest of the country. As job losses mounted in mediagenic New York and Los Angeles, his apparent indifference may have cost him a second term.

Now it’s George W.’s turn. Can he better manage the political pitfalls of the country’s strikingly uneven economic fortunes?

The most intellectually honest policy would be to tackle the root cause of the problem: the anti-growth elitism that makes California, the Northeast and similar urban areas so vulnerable to speculative volatility. As long as regulatory and political caprice increases the risk of all but a select group of activities, like the dot-com mania, slow-growth regions will continually foster a boom-and-bust economy.

This means, however, constraining the unlimited power enjoyed by the country’s most vocal, privileged and well-organized urban elites, which would sooner embrace evangelical religion than give up their perquisites. Unless the groups harmed by the urban status quo, such as the urban working class, lend support, the Bush administration would gain little, except virulent criticism, fighting to regularize the environmental, land-use and tax policies that hamstring the nation’s least-competitive regions. Poorer urban voters, of course, recently rejected the president-elect by remarkably lopsided margins.

Alternatively, Bush might try to prop up inflated new-economy assets like high-end real estate or technology stocks with tax and interest-rate cuts. That’s exactly what the Japanese attempted to do when their economic bubble burst in the late 1980s.

Terrified of the political and social fallout from bank failures and corporate bankruptcies, Japan repeatedly cut interest rates and ran unprecedented budget deficits in the hope that cheap money would eventually help troubled firms find a way to cover their losses. It never happened, and the Japanese economy stagnated. Unrealized losses accrued during its period of financial speculation repeatedly sapped the lifeblood from any potential recovery.

The United States faces similar risks. It’s unlikely that many, if not most, new-economy investments will ever pay off, no matter how strongly the economy is stimulated. Moreover, lower interest rates, as Fed Chairman Alan Greenspan ordered up last week, and across-the-board tax cuts, as Bush wants Congress to pass, will weaken the dollar and undermine the flood of cheap imports and foreign capital that makes possible America’s remarkably high consumption with low inflation. The powerful U.S. investor class might cheer a stock-market bailout, but, as in Japan, the costs could quickly dwarf the price of paying for the speculative excesses of the past.

That leaves the most calculating option: Let the largely pro-Democrat slow-growth economies gradually destroy themselves. If places like California and New York are unwilling to compete with the nation’s faster-growing and politically more conservative regions, why use federal power to change them? Left to themselves, divergent local policies and appetites for growth will only widen America’s regional-performance gap and expand the pro-Republican political base.

This process has already produced dramatic results. In 1992, Georgia, Texas, North Carolina and Arizona had just half the employment of California, New York, Illinois and Michigan, but they grew twice as fast over the next eight years. By the 2000 election, they had 60% of the bigger states’ job base and were on course to surpass them in another two decades. As recent census data shows, encouraging the nation’s conservative Southern, Midwestern and intermountain Western states to grow much more rapidly than their liberal counterparts directly translates into Republican political power.

The downside of this strategy is the potential for social unrest in relatively disadvantaged states. The 1992 Los Angeles riots, for instance, marred Republican reelection chances that year. Bush would also have to find a way to reassure his geographic base while media and political attention almost exclusively focused on the negatives of the hardest-hit urban communities.

Yet, a recession disproportionately centered in the country’s liberal strongholds might well generate support for pro-growth policies even in such recalcitrant regions. Economic setbacks could be blamed on local mistakes, not federal policy. Areas that simply refused to change would lose population, economic stature and, eventually, political influence.

For better or worse, a Bush presidency once again coincides with a time of troubling economic uncertainty. With American politics already broadly split among high- and slow-growth communities, the way the president-elect responds to the current slowdown may determine our country’s political tone and substance for years to come.