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The End of Affluence

1.

The last time Americans were strongly in favor of balancing the federal budget was during the Great Depression. Then, as now, the public generally thought that budget deficits were the cause rather than the result of their economic problems, and few politicians, including Franklin D. Roosevelt, disagreed or dared to contradict them. In his 1932 presidential campaign, Roosevelt criticized Herbert Hoover for not reducing federal deficits, and when the economy began to recover later in his first term, partly because of his own spending programs, he decided to deal firmly with the government’s growing deficit. By 1936, the deficit had risen to more than 5 percent of the gross national product, compared to less than 3 percent today. But FDR’s sharp cuts in government spending in 1937 did not have the effects he had hoped for; instead they contributed to a sudden, fierce recession later that year which reduced tax revenues and thwarted any attempts to balance the budget.

What FDR would learn during the next few years was that the opposite policy probably would have been preferable. Despite the Depression, the American economy retained so much capacity for growth that the stimulus of greater deficits, along with cooperative Federal Reserve policies to lower interest rates, would have expanded incomes and production rapidly—as deficit spending did during the war years—and probably raised tax revenues sufficiently to eventually eliminate the federal deficit. This of course is what happened after the war.1

Today, we do not have this option. Since the early 1980s, the United States has run large budget deficits year after year, yet the economy has grown unusually slowly during this period. In view of the economy’s performance, there is certainly no good reason to believe that still larger deficits would have raised the rate of growth during these years or that the financial markets would have permitted such deficits, even if the government had pursued such a policy. With even larger deficits, fears of inflation would probably have driven interest rates so high that the effect of any added stimulus would have been offset by the higher cost of borrowing. As it is, most forecasters, including those at the Federal Reserve, believe that the economy will grow by only about 2.5 percent a year. At that rate of growth we now have little choice except to reduce projected government spending; otherwise federal deficits will rise further, continuing to strain the world’s financial markets and diverting more scarce funds away from investment.

To most Americans, therefore, it appears that we have no alternative than to do what FDR did in 1937, despite the risk of recession that rapid reductions in the deficit might entail. While the American economy is of course not as fragile as it was during the Great Depression, partly because of such “automatic stabilizers” as Social Security and unemployment insurance, both the Republican and the Clinton administration’s proposals to balance the budget are likely to slow the economy still further. Both plans are likely to lead to lower tax revenues than we would otherwise have. Contrary to the Republicans’ own forecast, a prominent econometric forecasting firm, The WEFA Group, calculates that even if Federal Reserve policies encourage growth by lowering interest rates, the Republican budget plan would (1) shave economic growth by about .3 percent a year on average, (2) consistently raise the unemployment rate above current levels to more than 7 percent, and perhaps to as high as 8.5 percent, and (3) fail to balance the budget as promised by 2002 because of the shortfall in tax revenues.2 In my opinion, even this forecast may prove optimistic.

In view of such analyses, it is highly unlikely that cuts in government spending will by themselves solve our economic problems. A better approach would be to recognize that the fundamental problem is not the deficits themselves but slow growth, and to concentrate our attention largely on the problem of national productivity—the relatively low growth in the output of goods and services per hour of work that has characterized the economy for more than twenty years. If we recognize growth as the central issue facing the country today, we may be able to organize our scarce resources more effectively than the Republicans and Democrats have so far done with their broad budget proposals that do not address the specific failures of important parts of the economy. Ultimately, whatever we do, we may not be able to raise more than marginally the rate of productivity growth. But unless the rate rises from its historically low levels of the past twenty years, most other efforts we undertake to solve our economic problems will also probably fail.

The persistent decline in economic growth since 1973 has done far more damage than is generally realized. According to a former economist of the Organization of Economic Cooperation and Development, Angus Maddison, who has comprehensively compiled the long-term growth rates of the world’s nations, the American economy had been growing at an annual rate of 3.4 percent after inflation between 1870 and 1972. From a much smaller base in 1820, the annual rate of growth until 1972 had been 3.7 percent. But between 1973 and 1993, our economy grew at an average of only 2.3 percent a year after inflation (rising to 2.4 percent a year if we include the latest data for 1994). In no other twenty-year period since the 1870s has the American economy grown as slowly as it has since 1973, excepting the period that ended with the collapse in production early in the Great Depression. Though the US economy suffered many brief downturns over the past century and a half, it invariably recovered so robustly thereafter that it made up for these drops in production relatively quickly. Even the two sharp economic contractions before and after World War I did not reduce the average twenty-year growth rate as much as it has declined since 1973, a period moreover in which the labor force expanded rapidly as baby boomers and many more women went to work.3

It may at first seem unlikely that a mere 1 percent drop in the annual rate of economic growth can have large consequences. But the damage done by slow growth accumulates the way interest does in savings accounts. It does so slowly and almost imperceptibly at first, and then surprisingly rapidly over the years until we have fallen much further behind than we realize. During these twenty years, the loss of goods and services produced by the economy as a result of the 1 percent a year reduction in the growth rate has amounted to roughly $12 trillion (in 1987 dollars). By a conservative estimate, the typical family would have earned an additional $50,000 over these two decades as the demand for labor forced wages up had the economy continued to grow at its historic rate. That would have been enough for many Americans to put a down payment on the first house they have so far been unable to buy, or to buy the health insurance they couldn’t afford, or to send a child to college.

As for the federal budget deficit, not only would it have disappeared entirely had the country grown at its historic rate, but by the early 1990s the US would have run a substantial budget surplus. This would have happened because, with no change in tax rates, tax revenues would have been about $2.5 trillion higher over these years as personal incomes rose, and we could have avoided over half of the more than $4 trillion in federal debt we currently have. Interest expenses would thus have fallen sharply. The resulting budget surplus would have paid for health insurance for the 37 million people who have none, with some money left over to provide free day care for more children whose working mothers can’t afford it.

It would alternatively have been more than enough to provide as much in welfare for the poor as we now do for the aged in the form of Social Security. In addition, state and local governments would have collected nearly $1 trillion more in tax revenues for education and infrastructure. If the US had grown at its historic rate, we would also have had additional capital available for investment from higher individual savings and corporate profits of roughly $700 billion over twenty years. About 14 percent of everything Americans now spend goes to health care; but had the US economy grown at its historic rate, health care would have come to a more manageable 11 or 12 percent.4

No one fully understands how the damage done by slow growth is distributed among us, but workers have been hit especially hard. Average wages for most categories of workers have fallen; the poverty rate even for those who work full-time has climbed sharply; and, on average, incomes even for the best-educated among us have not risen nearly so fast as they did in the 1950s and 1960s. Differences in incomes are greater now than at any other time since the 1930s, giving the US the most unequal distribution of income in the advanced world. 5

Meantime, the costs of housing, education, and automobiles have been rising faster than American incomes. A lower proportion of Americans own homes than did so twenty years ago, especially those in the youthful home-buying years. The average number of cars per worker bought each year is down sharply from its level in 1973. And primary, high-school, and college educations are relatively more expensive than before, so that even well-to-do communities are cutting back on public-school spending. College students are taking increasingly longer to get degrees, as well as borrowing more from their parents and government to stay in school.6

These are the consequences of slow growth. Partly because few have understood what has been happening to us and we are consistently told by journalists and politicians that growth will soon resume, Americans have saved less and borrowed more in order to support the standard of living many have taken to be their natural right. Both public and private spending for health care has soared. The federal government raised spending on defense dramatically in the 1980s. There should be no mystery why the nation’s savings rate is so low or why federal deficits are so high.

In the past, when incomes were growing rapidly and seemed likely to do so forever, Americans were willing to subsidize welfare as well as new roads, public universities, space programs, and the construction of nuclear colliders. When growth was relatively rapid, Americans tended to be more open to ideas about including everyone in the American dream. They voted for politicians who advocated affirmative action, a war on poverty, Medicare and Medicaid, and generous student loans. But today, as slow growth makes it difficult for many of us to buy what we once did and impedes the steady financial progress that most of us once took for granted, these same programs are denounced as the work of a conspiracy of soft-headed liberals. The once popular idea that government should actively encourage equality of opportunity is now increasingly scorned. Many experts forget how much our democratic traditions contributed to our growth. Those traditions did so by favoring widespread ownership of property and a broad distribution of income, which created a powerful consumer market-place, as well as an openly competitive business environment, and a free public education system for all. Instead of addressing the slowdown in economic growth directly, politicians now address its symptoms, as if everything, from welfare to broken families to angry urban ghetto songs, is the cause and not, in considerable part, the consequence of poverty. If the American economy continues to grow at the same slow rate, we will lose approximately another $25 trillion in production over the next twenty years compared to what we would have earned had we grown since 1973 at what had been our historic rate. That loss would come to more than $75,000 a person, excluding the effects of inflation. Numbers like these change history.

  1. 1

    See Alan Brinkley, The End of Reform (Knopf, 1995), pp. 25–28. Also, Charles P. Kindleberger, The World In Depression, 1929–1939 (University of California Press, 1973), pp. 273–278.

  2. 2

    Kurt Marl and Daniel Bachman, “A Dynamic Analysis of the House and Senate Budget Resolutions” (Bala Cynwyd: The WEFA Group, 1995).

  3. 3

    Angus Maddison, Dynamic Forces in Capitalist Development, (Oxford University Press, 1991), especially pp. 50–53.

  4. 4

    These projections assume a 1 percent a year reduction in the rate of growth and no change in interest rates, tax rates, the savings rate, or labor participation. The calculations were made with the help of Data Resources Inc. In the first year, GDP loss amounts to only about $30 billion, but by the tenth year the annual GDP loss is almost $400 billion, and by the twentieth year it amounts to about $1.2 trillion.

  5. 5

    Average weekly wages of nonsupervisory workers are about 15 percent below what they were in 1973, adjusted for inflation. Even when worker benefits such as pensions and health insurance are included, as they are in the Commerce Department’s Employment Cost Index, average wages have at best essentially stagnated over these years. This is the worst performance over twenty years since the Civil War, even when most of the years of the Great Depression are taken into account.

  6. 6

    Housing data are taken from the Joint Center for Housing Studies at Harvard University. Car-sales data are from the American Automobile Manufacturers Association in Detroit. This trend began long before American autos were made significantly more durable.

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