Economy Needs More Than Anti-Recession Tinkering
THE economy appears to have weakened again after a modest improvement during the summer. Now a year and a half old, this recession is the longest since the Great Depression. December's unemployment rate of 7.1 percent is the highest yet in this recession. And most forecasts for the coming year suggest we will not grow fast enough to lower the unemployment rate much.
Many are asking an important question, "What should we do about the recession?" We should also be asking the more fundamental question, "How can we restore healthy long-term growth and raise the standard of living of the average American family?" Some policies that look appealing for getting us out of the recession look less appealing when we consider their impact on the budget deficit and long-term growth.
Primary responsibility for getting us out of the recession lies with the Federal Reserve. It dramatically - although belatedly - lowered interest rates in December, cutting the discount rate a full point to 3.5 percent. I do not expect the economic indicators suddenly to blossom. But lower interest rates will have an important positive impact on the economy.
In principle, fiscal stimulus could be a useful complement to lower interest rates in promoting a healthy recovery. But such stimulus would have to be carefully targeted and clearly temporary if it is not to hurt long-term growth by permanently raising the deficit.
America's fundamental economic problems will not be cured by a recovery from the recession. Real hourly pay of the average American worker is only 3 percent higher now than it was at the depth of the previous recession in 1982. This stands in marked contrast to the years from 1948 to 1973, when real wages grew 3 percent per year. In the 1980s families had to work harder and longer to get ahead.
Productivity growth is the key to raising wages and incomes and to making us more competitive internationally. American businesses have achieved increases in output per hour of about 1 percent per year over the last decade while the Japanese have raised their productivity four times faster. Much of the responsibility for improving productivity rests with the private sector. But government has a role to play. We must stop neglecting public investment in infrastructure, technology, and the quality of our w orkforce. We must stop encouraging consumption over investment.
The economy is not going to strengthen fundamentally until we boost saving and investment. And that won't happen until we bring down the budget deficit. Government borrowing crowds out money for private investment and drives up interest rates.
Congress is considering a number of anti-recession measures. And the president will offer his own program tonight in his State of the Union message. We have to resist the temptation to make politically popular tax cuts the centerpiece of any recovery program. Any tax cut large enough to matter for the recovery will be too large in terms of the budget deficit. And there is a real danger that we could have a tax-cut bidding war between Congress and the president.
I don't think we need a net tax cut. But tax reform that tries to restore some of the progressivity lost in the last decade makes sense on fairness grounds. It also makes sense to implement any tax reductions for lower- and middle-income taxpayers now, when they can provide some fiscal stimulus, and to defer the tax increases that balance these cuts until the economy is stronger.
A temporary investment tax credit may well be the most effective way to stimulate a stagnant economy. And grants to hard-pressed state and local governments can relieve pressure on them to cut worthwhile long-term investments in infrastructure and education.
I support congressional moves to cut defense spending and use the savings from Pentagon cutbacks to pay for deficit reduction and some more investment-oriented spending, such as for better health care, education, housing, and transportation. This re-orienting of our budget priorities is critical, but we must stick to our commitment to bring the deficit down.
It is very tempting to think that the answer to our economic problems is to reduce taxes. But the real challenge is to increase national saving and redirect our public and private spending toward more productive long-term investments.