Our economy is on the ropes. It may not be in a depression—yet. It may have spared you and your family up to now. But it’s in trouble, and despite a few recent glimmers of recovery, it’s going to remain in trouble for many months to come. Take capital investment plans. They’re down sharply this summer, a development that will reverberate throughout the economy at least until next year, and probably beyond. Whatever the hopeful signs, we’re still a long way out of the woods.
What do our political leaders propose to do about it ? The answer, only dimly grasped by the public, is nothing. The Republicans, echoing a refrain of 50 years ago, have settled on a prosperity just-around-the-corner position. The Democrats, having voted for the Reagan budget last year out of fear for their hides, voted for it this year (or refused to fight hard against it) out of lust for the hides of Republicans, who they believe can be saddled with full responsibility for the country’s pain and suffering come November.
Meanwhile everyone else is left without much to lean on, except some dearly held notions of the way the economy works, or is supposed to. Our purpose here is simply to bust a few of those mental blocks, and to get people to open themselves up to some different approaches. Several of these approaches should be tried right now, to help keep us from sliding into a depression. Others should be tried in the long term, to help restore permanent health. Some of the ideas on this whirlwind tour will make you uncomfortable. They should. The state of the economy has reached the point where disturbing solutions may, be the only kind we have.
1. Spend, Don’t Save.
Somehow a fiction has arisen in recent years that consumer spending is a bad thing, that it’s better to “save.” Sure, saving is important when it results in genuine capital formation that can build new factories. But it doesn’t do any good under mattresses or in money market funds, where ten million people now put more than $200 billion in assets. Most of this money ends up in short-term commercial paper, government securities, or other investments that do not produce new plants or provide new jobs.
Spending is a better idea, especially right now. The only way to get out of the recession and have a permanently growing economy is for people to buy a lot. Increased buying means increased orders, which mean increased production and increased jobs and growth. Inflation doesn’t result from such growth per se, a point that many people don’t seem to understand.
If we’re going to have more buying, we need more disposable income, and that’s why almost everyone agrees that a tax cut this year is necessary. The question is what kind of tax cut. The Reagan plan increases the disposable income of people making $100,000 a year by 6.6 percent (10.3 percent next year). It increases the disposable income of people making $15,000 by 1.6 percent (3.0 percent next year), and social security taxes wipe out that. As we’ve seen, those at the upper end of the scale tend to invest their money in interest. (If they were putting it into the productive economy we wouldn’t have this kind of recession.) Those at the middle and lower end of the scale tend to spend their money when they get it. Because the country needs more spenders and fewer money marketeers, we need to adjust our tax policy to give middle and lower income people more. It’s not only fairer if you believe in redistributive justice, but smarter if you believe in saving the economy.
2. Politicize the Fed
Ronald Reagan may not know it, but all the tax cuts in the world won’t induce people to invest productively if interest rates don’t come down. In order to bring them down, Congress must break the mystique of the Federal Reserve Board and force some loosening of the money supply (see “Defrocking the Fed,” June).
Under the Constitution, Congress has responsibility for monetary policy. The Fed is by law its servant. Thus, granting the Congress and the public some voice in determining the price we all will pay to fight inflation is not the irresponsible position you have been led to believe. So far, Paul Volcker has been allowed to wage the war alone. As recession casualties mount, he and a shamefully large body of respectable opinion makers have scoffed at the idea of “political” accountability. That accountability must now be enforced. Volcker should be made to return to the Fed’s pre-1979 operating procedure, which allowed it to set short-term interest rates directly. The economy needs more oxygen, and the Fed’s money supply targets must be expanded to provide it.
3. Cut Defense Today—Not Tomorrow
Congress has to grow up a little, too, showing long-term financial markets that it has the discipline to reduce the huge deficits of the next several years. The lack of confidence caused by the prospect of those future deficits translates into an unwillingness on the part of investors to take a chance on the long-term future of the country. We might want investors to take a cheerier approach, but without an encouraging sign, they won’t.
So Congress must recoup revenue by rescinding some future tax cuts (particularly those for the wealthy), paring back entitlement programs, and cutting defense spending. The reason cutting defense is a short-term necessity is that with any more delay, the boat will be over the falls: the money will be committed, the unnecessary weapons in production, and the massive future deficits inevitable. On the other hand, if the cuts were made right now, more than $250 billion could be saved by 1987 without weakening the defense at all (see “35 Ways to Cut the Defense Budget,” April).
If defense spending created a lot of new jobs to get us out of the recession, the Reagan plan actually might contain a silver lining. But this spending won’t have a multiplier effect—at least not for a few years. “The days of Rosie the Riveter just aren’t the case anymore,” the vice president of Boeing told The New York Times. McDonnell Douglas, the nation’s largest arms contractor, sees no significant employment increase until 1984. The sectors of the economy where defense-related jobs will eventually become available—engineering and other areas of technical expertise—are now experiencing near or full employment.
Meanwhile the dimensions of the buildup and the possibility that its real cost was underestimated (some in the Pentagon say by as much as $750 billion) help assure high deficits and a crippled economy for years to come if the cuts aren’t made soon.
4. Bust the 1983 Budget Some More
While everybody knows the staggering budget deficits projected for future years spell disaster, it’s important to remember that in the short-term i.e., this year—the deficit isn’t much to worry about. “When you’re in a recession, deficits are a partial consequence of that recession, and of efforts to get out of it,” says Barry Bosworth, an economist with the Brookings Institution. Even the most ardent believers in the theory that deficits cause inflation have a hard time suggesting that they do so in the midst of a recession.
The first 1983 budget resolution will feature a deficit in excess of $100 billion dollars. Because we’ll have a deficit of this size no matter what happens, we might as well try to ease the pain for some of the victims of the Reagan/ Fed policy. It would be nice if we could do this in place of some of the defense spending increases, but if anti-recession programs have to be funded in addition to defense boosts, we can survive it. Adding another $10 billion or so to a $100-billion deficit isn’t going to make any difference. Honest.
The list of harmful cuts that need reconsideration is long, but the one that probably hurts victims of the recession most seriously is food stamps. You might say that the words “food stamps” and the odious images they conjure up for many Americans had a lot to do with electing Reagan. But the fact remains that this is the most successful of all social welfare programs. It is one of the few antipoverty programs where most of the money is guaranteed to end up in the hands of the intended recipients instead of being wasted in layers of bureaucracy. Because of its success, fewer people than ever go hungry in this country. The food stamp program needs some reform, but even Senator Robert Dole, hardly the picture of softheaded liberalism, believes the $1.5 billion in cuts in the 1983 budget resolution is heartless.
5. Forget “Free Trade”
To Americans, “free trade” is a religion. To the rest of the world, it’s a tool—something to be embraced when it serves the national interest and discarded when it does not. This is changing, as certain U.S. industries (most recently sugar) clamor successfully for protection. But in critical industries—such as autos—it’s not changing fast enough to allow the flexibility we might need to stave off depression. While a free trade policy is clearly desirable in the long term, right now we have to start acting more like our allies. The days of the American Santa Claus are over.
That translates into a concept Senator John Danforth calls “reciprocity.” Under his proposal, foreign countries would be required to grant the same access to U.S. businesses as the U.S. grants theirs. If they didn’t, trade laws would be amended to allow the president to take retaliatory action. This wouldn’t eliminate our $18-billion trade deficit with Japan, and it wouldn’t automatically open up their markets to our beef, citrus, semiconductors, and other products. But it could send the right message and help eliminate the “non tariff barriers”— the Japanese standards on baseball bat labels, the British requirements on killing chickens, for example—that are used by our allies as not-so-subtle excuses for keeping American products out.
Let’s say you pick up some American-brand soup in France. Chances are it will say something like “Canned in Cannes.” We’ve got to start thinking this way too, as the UAW does in arguing for a bill that requires a certain percentage of the parts in a car sold in the U.S. be built in the U.S.—even if by a foreign manufacturer. If things get a lot worse—if a depression develops—we just might have to open our minds to the distasteful proposition of a full-scale embargo on cars. Merely the threat of one would tell the Japanese that—so sorry—the survival of our economy is more important than international goodwill. If such an emergency arose, the deal should be that domestic manufacturers not raise prices during the embargo, and that if they blew this chance to get back on their feet, they could expect no further help.
Given the choice, most of us prefer to think and read about zoning board hearings, the Law of the Sea Conference—anything but international trade. That’s got to change. Americans had better get interested soon—and wake up to the fact that we’re letting other countries commit unnatural acts against us.
6. Reward Pie-Enlargers
The one reform that could do the most to improve the overall productivity of the American economy is easy to grasp. All tax breaks, tax credits, direct subsidies, and any other means the government uses to shape economic behavior should be directed toward rewarding investment only when it goes for something new. The rearranging of existing assets that so occupies the attention of our brightest lawyers, accountants, and businessmen is almost entirely unproductive and should go unsupported by the government and the rest of us.
The general idea is that if, for instance, you built a new house (or renovated an old one), thus creating employment that radiated through the economy, you would get a home mortgage deduction. But if you bought an old home, which involves no investment in the productive economy, you would not. Imagine the effect on the housing market if nine or ten new homes were built for every three or four traded. The supply would rise and soaring housing prices might well stabilize—or fall.
Another example: if a company borrowed money to open a new factory or develop a new product, it could write off its interest payments. But if it borrowed money to acquire another company, it could not.
Not all rearranging of existing assets is unproductive, but enough of it is that pie-enlarging must take precedence over the pie-slicingthat has come to dominate economic activity. As Harvard’s Robert Reich points out, the fact that productivity has declined and conglomerate mergers have increased during the same I 5-year period is hardly coincidental. Reich, Lester Thurow, and others have pointed to the need for the government to design policies that reward businesses that are more growth-sensitive and less dividend-sensitive; in other words, more focused on long-term productivity and less focused on short-term profits.
Gary Hart, taking on the capital formation problem, has a sensible proposal for something called “New Capacity Stock,” which would be exempt from capital gains tax on its first resale, and would be issued only to raise revenue to pay for new plants, new equipment, or new research and development.
Another pie-enlarger concept is investment in “human capital,” which is a hokey way of saying we need better education. It’s a defense matter— the Soviets are training twice as many scientists and engineers each year as we are—but it’s also a critical economic issue. Making American education work better requires not just more money, but higher quality teachers and tougher performance standards. That means taking on the teachers’ unions and colleges dedicated to perpetuating incompetence in the classroom (see “The Class War We Can’t Afford to Lose,” June). Bad teachers drain “human capital” as surely as unproductive investments drain other kinds of capital from the economy.
7. More Government Control
Monetarists believe inflation is caused by too rapid an expansion in the money supply. A more logical and sophisticated analysis suggests that this expansion of credit is just an accommodation of inflation elsewhere in the economy, and that if we don’t do anything about these root causes of inflation, we can inhibit the disease only in a temporary and crude way—by causing a recession. The root causes aren’t hard to figure out.
They are: the cost of oil (above all else in the 1970s), health, and food; the granting of wage increases without parallel productivity increases; and the institutionalization of inflation through automatic cost-of-living adjustments.
No matter how tight the monetary noose, inflation could easily return, if for no other reason than that OPEC, only recently given up for dead, is about to stage a comeback, featuring price increases of $5 to $6 a barrel. The best defense against oil shock has always been relatively straightforward: reduce imports through conservation, which Jimmy Carter began to do; fill a strategic petroleum reserve, which Carter made a stab at; and plan for standby gas rationing, which he rejected. The last of these may be the most potent weapon against OPEC we could possess. The mere threat of rationing in the U.S. probably would be enough to hold down the world price, but even if the plan actually had to be imposed, it would be a far less painful way to fight inflation than the way we’re fighting it now.
The same could be said for a National Health Service, which, contrary to myth, would bring down the cost of health care, a sector now eating up nine percent of the American gross national product. Private insurers have shown no ability to contain costs, and the Medicare and Medicaid systems allow hospitals and doctors to set prices, which guarantees higher and higher fees and inflation. Government control of medical costs is the only answer. If you need more convincing, look at Britain. For all its flaws, “socialized medicine” works—which is why even Margaret Thatcher and the Tories support it.
Dramatic increases in commodity prices are considered another culprit in inflation, as are costof-living-adjustments. COLAs don’t just “keep pace” with the disease, they perpetuate it. These adjustments were designed for people On fixed incomes, but they have spread to every sector of the economy and are routinely granted without regard to the true economic circumstances of the recipients. Federal employees have made out particularly well (with twice-a-year adjustments). But the real income of almost everyone on COLAs has risen faster than inflation.Dramatic increases in commodity prices are considered another culprit in inflation, as are costof-living-adjustments. COLAs don’t just “keep pace” with the disease, they perpetuate it. These adjustments were designed for people On fixed incomes, but they have spread to every sector of the economy and are routinely granted without regard to the true economic circumstances of the recipients. Federal employees have made out particularly well (with twice-a-year adjustments). But the real income of almost everyone on COLAs has risen faster than inflation.
The way to end the havoc COLAs wreak is, as Stephen Goldfarb has suggested, to give the president the right to rescind them across the board when necessary. That way the 58 million Americans with COLAs who until now have had no stake in fighting inflation would have to join the rest of the sufferers.
Just as the president must have standby authority to impose gas rationing and rescind COLAs. he needs emergency powers to establish wage and price controls. Congress should delegate this authority to the executive. If Congress itself retained it, firms would quickly learn that controls were coming and raise prices in anticipation. Only presidential action contains the element of surprise that’s required for controls to work.
And they can work—in the short-term. Like rent control that lasts too long, long-term wage and price controls eventually cause distortions in the market. But as a way of breaking a wage-price spiral, they are a perfectly legitimate part of any inflation-fighting repertoire. A myth has developed that the lifting of controls in the early 1970s gave us the serious inflation that followed. While lifting controls naturally caused some inflation, the real reason the rate exceeded its earlier level is more complicated, involving a number of developments, including the 1972 Russian wheat deal and the 1973 Arab oil embargo.
By going after inflation’s root causes—and by equipping the president with emergency powers that have some bite—the government can develop a policy that goes beyond simply shutting down the economy.
8. Get the Rich Off the Dole
If the government is going to continue to meet its important obligations, it cannot afford to hand out money to people who don’t need it. That seems like a simple enough proposition, but making it a reality requires rethinking a number of programs, starting with social security.
On one level social security is just another income transfer program: the money received by the old comes from the young, not from some nest the senior citizens created for themselves during their own working lives. In that sense, the only difference between social security and regular welfare is that one is paid for through payroll taxes and the other through income taxes. But even if you believe social security is different—that it is “insurance”—the rich still shouldn’t get it. The program should be insurance against need. Do you collect from your insurance company if you don’t have a fire? Then why should millionaires like Rep. Claude Pepper get social security?
According to the congressional budget office, simply taxing half the social security benefits of recipients with incomes of more than $25,000 could save $1.6 billion in 1983 and $3.1 billion in 1987. Taxing the whole benefit would obviously double the annual revenue, and imagine what eliminating those benefits entirely could save.
Now imagine what would happen if we eliminated veterans’ benefits for people like John Glenn and unemployment benefits for the Carter administration’s wealthy senior staff members who applied for relief shortly after leaving office. If we want to have enough money for people who need it, we’ve got to establish “means tests,” not just for some government programs, but for all of them.
9. Get the Poor Off the Dole
Right now there are ten million unemployed, but even after the recession ends many millions will remain jobless. Many economists say that the U.S. shift away from heavy industry and into high tech will result in a number of years of large-scale unemployment that will affect millions of people who have some skills and are willing to work hard.
Fortunately there’s something for them to do. The nation’s “infrastructure”—its roads, bridges, transit systems, and sewage facilities—is crumbling. Most cities and states don’t have the money to fix these things, and because it’s hard to see anything amiss until the buckling and bursting begins, deterioration is easy to ignore. But the problems clearly exist, many billions of dollars worth, and the most affordable way to fix them is to employ workers laid off from other jobs.
Recent public sector jobs programs like CETA haven’t worked very well, but earlier experience indicates that when unemployment is severe and the projects well thought-out, jobs programs can be successful. Take the Depression-era Civilian Conservation Corps, which was created by Congress on March 31, I 933. By mid-June of that year, 1,300 camps had been established, and by the end of July more than 300,000 young men were at work, for the most part on sensible projects.
The infrastructure project is not only sensible but urgent. The U.S. Interstate Highway system contains 42,500 miles of roads, at least half of them in serious disrepair after two decades of use. Reports delivered to the Department of Transportation by state governments indicate that fewer than a third of our state roads are in good condition. Some bridges, transit systems, and sewers are in even worse condition.
Aside from getting federal, state, and local governments to fork over the money (which they’ll have to do as the problems become more obvious), the biggest obstacle may be the unions. They must be convinced that employing two workers to fix a road at $5 or $6 an hour apiece is better than one worker at union scale. If the unions go along, the project could fly; if they don’t, the job creation may have to take place without them.
10. End the Sucker Problem
When it comes to the decline of dynamic American industry, there’s more than enough blame to spread around, starting with short-sighted business school managers who flit from one company to another, expending their energies on short term profit rather than long-term re-tooling. But there’s another reason for the decline: wage increases have so far outstripped productivity increases that the company starts to sink of its own weight. This is also a major cause of inflation.
The unions quite logically respond that if they hold down wage demands the money from increased productivity will simply end up in the pockets of management and shareholders, whose compensation is already exorbitant in relation to the company’s condition. Why should the union act like a sucker?
In order to eliminate the sucker problem, we have to start looking for solutions like that proposed by Senators Richard Lugar and Paul Tsongas during the 1979 Chrysler bail out debate. Their plan was that instead of a wage increase, workers would get stock, so that if their work and wage freeze helped make Chrysler profitable again, they would share in the rewards.
The unions rejected the plan and it failed in the Senate, but the idea is an essential one for the future of American industry. Getting a grip on inflation and productivity problems requires wage restraint, and wage restraint requires that workers be promised the possibility of some future payoff. Its a fair deal for labor and management, and one they had better start making soon.
