The economic recovery now under way appears to have increasing strength and momentum. The stock market has moved up dramatically, interest rates have come down significantly, consumer spending is up, inflation is down, production is growing. That is welcome news to everyone. There are two possible explanations for this recovery. One is that supply-side economics works and that the Reagan tax and budget programs enacted in 1981, together with monetarism, are producing long-term economic growth with low inflation and high investment. The other is that we are experiencing a normal, or slightly subnormal, cyclical rebound after a steep recession, stimulated by consumer spending, high deficits, and easy money—in short, a classical Keynesian recovery.
Of the two explanations, the second one appears to me closer to the mark. Last summer monetarism, coupled with the deficits created by the 1981 budget program, produced the steepest recession since World War II, with the highest real interest and unemployment rates, and almost bankrupted the world. When some of our largest companies and credit institutions, followed by Mexico and Brazil, went to the edge of bankruptcy, the Federal Reserve reversed its tight monetary policy, lowered interest rates, and increased the money supply significantly. This reversal, helped by last summer’s tax package, permitted the present recovery to take hold. Inflation has been brought down dramatically by a worldwide contraction caused by economic austerity, by the creation of 35 million unemployed in the industrial world, by the sharp reduction in oil prices as a result of reduced consumption, and by lower food prices as a result of good harvests and good weather.
The boom in the stock market was set off by lower interest rates driving funds from money-market accounts into equities, as well as by huge inflows of foreign capital from investors who looked to the dollar for political insurance and to our economy as the only safe haven. It was at least partly this inflow of foreign capital that permitted our deficit to be financed while a minimum number of borrowers were crowded out, and interest rates were significantly reduced.
Given the depth of the recession and the stimulus provided by a $200 billion deficit and easier money, a recovery had to happen. It is consumer led, deficit financed, and classically Keynesian in character. It is also pushed along by the stock market. The boom in the market has increased market values by over $600 billion since last summer. Business Week cites a rule of thumb that 6 percent of increased market values is translated into consumer spending. This alone amounts to almost $40 billion. The stock market boom has also brought with it vast speculative excesses that make the 1960s look tame, and that should be viewed with serious concern.
This is not to deny the real achievements of the Reagan administration. By the end of the last administration, we were headed for an inflationary disaster. Partly as a result of its own failures and partly as a result of forces beyond its control, the Carter administration left a legacy of double-digit inflation, 20 percent interest rates, and a runaway budget. The Reagan administration, with considerable help from the Federal Reserve and its chairman, Paul Volcker, was able to change the country’s direction, and sharply reduce the rate of inflation. President Reagan has managed to convince a majority of Americans that a price has to be paid for this change in direction, and many people have responded favorably and with greater patience than might have been expected. These are considerable accomplishments on the part of the president, although it is hard to deny that the price that was paid was borne by those least able to afford it.
Business, especially big business, will come out of the recession far stronger than before. Sharply reduced costs and break-even points, higher liquidity as a result of lower interest rates and high stock prices: these will result in significantly higher profits and competitive positions for most of our large companies. In addition, the president seems to have luck on his side. The fall in oil and food prices did much to reduce inflation. Under President Carter, food and oil prices rose, and there was little he could do about it. Luck should not be sneezed at; we can be impressed both by President Reagan’s achievements and by his lucky star. And whatever the shortcomings of his policy, a better one has yet to be spelled out.
However, despite a clear upturn in the economy, not many of our fundamental problems have been addressed; the future is heavily mortgaged and inflows of foreign capital have pushed the dollar to punitively high rates. We are still looking for the formula that will lead to stable growth, low unemployment, reasonably balanced budgets, and a reasonably valued currency.
Why are these goals so elusive? The reason, I believe, is that there are fundamental and increasingly acute contradictions in our social and economic structures that we fail to recognize. The “American century” proclaimed by Henry Luce in 1940 lasted only twenty years. From 1965 onward, the United States entered a period of transition which, if anything, is accelerating rather than abating. The difficulties of adjusting to a world we no longer dominate are creating many of the contradictions we are facing today.
We now hear intense arguments about the excessive size of the defense budget, of entitlements, taxes, and deficits. These are important issues, but they may be the result, and not the cause, of many of our difficulties. Instead of relying on economic projections, which turn out to be erroneous as frequently as not, we might more wisely look at some of the underlying trends and try to do something about them.
To begin with, we all talk of the obligation to provide, at the very least, the opportunity for employment to all Americans seeking it. We have all heard that high technology creates higher requirements for skills and fewer requirements for labor. So does the shift of much of the economy from manufacturing products to providing services. But a conservative political and economic policy aggravates this situation by fighting inflation with high unemployment. In England, Germany, and the United States, inflation is controlled by high interest rates and slow growth; the byproduct of such a policy is an almost permanent high level of unemployment. This may be our most fundamental contradiction.
Next comes education. Two decades after dominating the world industrially, we are trying to bring Japanese methods into our factories. We might do better to compare the quality of Japanese elementary and secondary schools to that of our own schools. We cannot produce goods efficiently if our children are not taught how to read and count. Insofar as higher education is concerned, neither supply-side nor Keynesian economics will enable us to compete tomorrow when we produce lawyers and MBAs by the tens of thousands instead of teachers, scientists, engineeers, and chemists. Fortunately for us, Japan is opening its first business school in the near future. This is likely to produce a measurable drop in Japanese productivity. It will, however, not slow them down sufficiently.
Education and judgment are not helped by the fact that 150 million TV sets in American homes are now turned on for an average of forty-seven hours per week. This is expected to increase to fifty-four hours during the next few years. At a time when our society needs thoughtful, educated, and discriminating voters more than ever before, television programming produces, for the most part, an intellectual desert; and TV news is unable to present complicated, ambiguous, or abstract issues.
The goals of state and federal budgets create further contradictions. American cities are falling apart; the needs for public reconstruction are obvious. Basic American industries are besieged by foreign competition on the one hand and recession on the other. We are proposing huge additional defense expenditures, but we are not willing to involve our government more actively in rebuilding our own cities and factories. There is no economic or philosophical difference between the government financing needed for defense and the government financing needed for public investment.
During the last decade, there has been a relentless erosion in the vitality of our older cities and of our older industries. Particularly in the northern half of the US, but also in some parts of the Sunbelt, cities and businesses have suffered together. The result has been high levels of unemployment, erosion of services and the tax base, and emigration to richer parts of the country by those able to move. (The tables on the next page suggest some of these trends.)
Beyond our borders, our policy of high interest rates and slow growth has bankrupted a large part of the world, including Mexico, which now poses the most serious problem for US foreign policy. The response from Mexico is heavy emigration to the US, both legal and illegal. This new flood of immigrants will compete with other minorities, inner-city blacks, and technologically unemployed whites for tomorrow’s jobs. The ugly racist demonstrations against immigrants during the recent elections in Germany and France should be cautionary for us here. The black community in America will expect whatever political power it can muster to be translated into tangible social and economic gains. It is questionable whether social and economic realities can accommodate such demands, unless we can sustain much stronger and evenly distributed economic growth.
And while this is happening, the chaotic international monetary system badly needs American leadership which we refuse to provide, while we complain, quite properly, that the unwarranted weakness of the yen and the deutsche mark is destroying American industry by pricing American exports out of the international market, and by displacing American products with imports. The recent economic summit only pretended to deal with these problems.
Such contradictions can only be dealt with through changes and adjustments in the long-term social trends that work against healthy economic growth—the shift of population and industry away from the northern part of the country, for example, and the decline in the use of industrial capacity and in the quality of American education. Only institutions that can take the long view and act accordingly will be able to bring about the kinds of changes that are required.
If such institutions are to be created, an active government and realistic leaders of both business and labor will have to work jointly to create the political climate in which contradictions can be confronted frankly. This type of cooperation does not imply a sinister corporate-statist conspiracy at the expense of the public or of democratic accountability. Preserving the environment, occupational safety, consumer protection, affirmative action—these and many other issues central to the public interest can and should be an essential part of any arrangements by which business, labor, and government cooperate to save the economy. Such cooperative arrangements, in my view, are needed to deal with the budget and with our industrial and regional weaknesses; they are also needed to coordinate stronger economic growth policies with our allies and to deal with third world debt.
First, the budget. In 1975, New York City did not face up to its runaway budget problems until the financial market refused to absorb any more of its notes. Sooner or later, the US will have a similar problem financing deficits of $200 billion and more. An occasional deficit, even one as large as the present one, can be financed and can even be beneficial to recovery, as we are seeing right now. This, I am sure, is a somewhat recent discovery for many of my conservative friends. However, another five years of such deficits, or anything close to them, will push the national debt up from its present $1.2 trillion to almost double that amount, or between $2.2 trillion and $2.4 trillion.
The interest alone on such a national debt would be over $200 billion annually. No conceivable growth in GNP will enable the US to afford such interest payments. Sooner or later, sharp cutbacks will have to be made in the growth of social costs and military spending; and measures to raise new revenues will have to be enacted. They should include taxes on consumption as well as taxes on income. I have, for example, consistently favored a 50 cent gas tax per gallon which could produce up to $50 billion a year in revenues. I would combine it with a minimum corporate income tax of 25 to 30 percent and a simplified personal income tax, as proposed by Senator Bill Bradley (New Jersey) and Congressman Richard Gephardt (Missouri), which carries a maximum rate of 28 percent. Such a tax package should be phased in as the economy recovers and be designed to produce about $75 billion annually by the third year. Savings in entitlements and the military should be enacted in order to produce an equivalent amount. As a result, the deficit should be brought to below $50 billion by the fourth year, and, as part of such a comprehensive plan, the Federal Reserve could bring interest rates down by at least another two or three percentage points. A 6 percent prime rate and long-term rates under 10 percent should be the result.
Arguments are now being made for policies quite different from this one: for consumption taxes such as a value added tax (VAT) to stimulate investment; for the Laffer curve to justify supply-side economics; for reductions in taxes on capital; for innumerable complex reforms to close loopholes or provide incentives. The efficacy and fairness of such measures usually lie in the eye of the beholder. Estimates of revenues raised or lost as a result of such suggestions are almost invariably highly speculative.
I approach the subject, therefore, with skepticism and uncertainty. I believe that taxing all consumption is regressive and counterproductive; in the case of a VAT it only duplicates many state and local tax schemes which largely depend on sales taxes. Furthermore, the economic health of the US is too heavily tied to strong consumer spending to risk imposing much heavier taxes on consumption. We can now see, for example, that the failure to stimulate investment after the 1981 tax cuts can only be reversed if very strong levels of consumer spending pull the economy out of the recession.
I believe, however, that higher taxes on energy can be absorbed by the economy. The effects of a heavy gas tax can be mitigated by rebates to lower-income groups and by shifting to smaller cars that use gas more efficiently. Sales of big cars are booming again and companies such as GM and Ford are unable to meet the current standard for mileage per gallon of gas. Our automobile industry has invested close to $100 billion to build efficient cars over the last decade, yet we are now acting as if the 1973 and 1979 oil shocks never occurred. A stiff gas tax will raise revenues and drive us back to less consumption of gas. Both are desirable.
So, in my view, is a minimum corporate income tax. We hear that such a tax inhibits investment and growth. But adequate capital formation can be encouraged by lower capital-gains taxes, reasonable maximum tax rates for earned and unearned income, and, possibly, shorter holding periods on securities transactions. (Most of these have been enacted in the last few years.) The corporate income tax is clearly justified on grounds of equity. According to estimates by Data Resources, Inc., corporate earnings for fiscal 1985 will be about $282 billion. The Congressional Budget Office estimates that corporate tax payments in that year will be some $65 billion, or about 23 percent. Such estimates are always tentative; but it seems plausible that a 30 percent tax rate could provide about $20 billion in additional revenue.
At the same time, the entire tax system would benefit from the proposal of Senator Bradley and Congressman Gephardt for simplifying both personal and corporate income taxes by reducing the number and amounts of income tax deductions. Their plan for three “steps” of tax levels, with a maximum personal income tax of 28 percent, would be fairer and simpler than our present tax structure, with its innumerable loopholes. One strong advantage of the Bradley-Gephardt plan is that the indexing provision, passed in 1981, could also be repealed. The argument that inflation pushes taxpayers into higher and higher brackets loses much of its force if the maximum tax rate is 28 percent. Eliminating indexing would return approximately $6 billion to the Treasury in fiscal year 1985.
In any case, resolving the budget problem cannot be postponed until after the 1984 elections, as some political analysts have suggested. Instead of remaining aloof from the congressional budget process, the president should take the leadership on this issue now. Senator Robert Dole has called for a “budget summit,” and such a meeting seems to me imperative. It should include the president, the leaders of Congress, and the chairman of the Federal Reserve.
If deficits are cut by the kinds of reforms I have suggested, then lower interest rates and a cheaper dollar would permit us to conduct a more coordinated policy for promoting growth in concert with our OECD partners. This would improve our exports and would also facilitate dealing with the $600 billion of third world debt that is both an economic drag on the West and a continuing danger to our banking system. Stretching out part of this debt at lower interest rates would provide additional stimulus to long-term recovery as well as protect the banking system.
I do not see how this can be done, however, without a major restructuring of the debts of the third world countries. This would require that Western governments give some guarantees to the banks and that the banks then extend the period of the loans and lower the interest rates paid for them. We now deal with third world debt by relying on the practice of limited “rollovers” of loans, at extremely high interest rates, in the hope that Western recovery will sufficiently stimulate third world exports. We hope that the poorer countries will then be able to make larger payments on the interest and principal they owe. But we may not attain sufficiently strong Western recovery unless the third world can import large amounts of Western goods. If we examine Western economic growth during the 1970s, we will find that it was significantly fueled by Western exports to the third world. Higher exports are equally necessary now, but they are in flat contradiction to the austerity and deflation often imposed on the poorer countries by the International Monetary Fund. The social pressures created locally as the result of such policies may not be politically tolerable for very long.
Our present policy of renewing loans was highly successful in avoiding disaster last summer when Mexico and Brazil were on the brink of collapse. In the long run, however, it is likely to cause heavier and heavier burdens of debt without providing the financing for sustained growth. From an accountant’s point of view, the policy of “rollover” may give the banking system the appearance of having sound balance sheets; it will do nothing to improve the underlying reality. Brazil’s acute difficulties in servicing its debt this summer show once again how precarious that reality can be.
Whatever happens, significantly greater credits for the third world will be required from the Western banking system than the system can now provide. The amounts of money on loan are simply too great. There are two ways of coping with this: either limit the risks posed by existing loans through the type of restructuring I have proposed; or limit the banks’ risk on new credits by some form of multinational guarantee. One or the other approach will be needed for adequate future financing to permit third world and Western growth without unacceptable risks to the banking system. They are two sides of the same coin. Not only must the IMF and the Bank for International Settlements continue to work out third world debt problems, but the activities of the World Bank and the regional organizations should be expanded.
In addition, carefully prepared international monetary conferences should recommend a new system to limit the fluctuation of the main Western trading currencies to manageable levels. Ways should be found for the officials of industrialized countries to collaborate in setting workable targets for the relative values of their currencies. This will be technically difficult to do. The central banks would have to collaborate to some extent on monetary policies and on managing foreign exchange. However, when such different leaders as Helmut Schmidt and Giscard d’Estaing recommend that a new system for coordinating exchange rates in needed, our own experts should seriously consider what they say.
The US is currently providing political insurance for virtually all the flight capital in the world at no cost to the insured and at enormous cost to ourselves as a result of an overvalued dollar. It is by no means certain that the lowering of interest rates alone, especially if they are not lowered sharply, will bring the dollar into more rational alignment with the deutsche mark and the yen. Without such a realignment, we will sooner or later inevitably resort to protectionism.1 The only long-term alternative to protectionism is an orderly international monetary system. It will not occur on its own.
When we come to the domestic economy, how can we make sure that inflation will be kept down and employment pushed up while the economy grows? I have always been tempted by some kind of legislated, tax-based incomes policy to control inflation—with tax advantages going to those whose wages and prices do not exceed inflation, and tax penalties being applied to those whose wages and prices do. I am inclined to think, however, that this would be cumbersome and impractical to administer fairly.
A different policy that might eventually achieve roughly the same result would encourage the gradual abandonment of multi-year labor contracts, with their built-in and often inflationary cost-of-living allowances. Instead the government could emphasize the advantages of one-year labor contracts that provide for sharing future profits with employees or for bonuses based on productive performance. This would come closer to the Japanese and German systems whereby the “spring offensive” negotiations over wage increases in different industries consist of bargaining over the shares of capital and labor in past and future gains. No American government should interfere with the rights of unions and management to make contracts; but government policy could support one-year contracts by making credit available through a new Reconstruction Finance Corporation as well as through special trade or tax advantages that would be recommended by a national Economic Development Board. Emphasis on such one-year labor contracts, linked to profit sharing and higher productivity, could also become part of a new approach to cooperation between business, labor, and government that would be the basis for an explicit industrial policy.
There has been a widening—if still vague—agreement that some kind of national industrial policy is needed to arrest the decline of our basic industries and the decay of our cities, and to deal with our failure to compete with other countries. But industrial policy does not mean that a central government agency should “pick winners” by giving promising companies special financing. Nor does it mean that the same agency should simply “bail out losers.” It does not mean favoring “high tech” or “low tech.” Such a policy should start by recognizing why many of our basic industries are failing and by examining what can be done about it. Our automotive industry needs to be reorganized to make it competitive in cost and quality with its foreign competition. Unrealistic foreign exchange rates must not be allowed to destroy our domestic manufacturers. Our steel industry has to be modernized so that it can compete with the automated mills abroad. We must maintain a competitive machine-tool industry.
An industrial policy, in my view, should also include a long-term program for energy independence (regardless of short-term reductions in oil prices) and additional government support for technological research and development efforts that individual corporations cannot undertake. Such a policy would also call for major investment in transportation systems and harbors to help our exports. And it would mean improving urban “infrastructure,” including schools, mass transit, sewers, etc., as well as the environment, in order to maintain regional balance and to improve quality of life.
Would such policy be possible in the US? It could only be carried out by a president who sought to create a consensus that cut across party lines and had support from major forces in American labor, business, and finance. A group of business and labor leaders (of which Irving Shapiro, Lane Kirkland, and I are chairmen) has been studying different approaches to a national industrial program. Its work is by no means complete and many different points of view are being examined. One of the proposals being considered would create a tripartite economic development board, along the lines of the one briefly proposed by President Carter in 1980, which was to have had Lane Kirkland and Irving Shapiro as chairmen. Made up of representatives of business, labor, and government, such a board could be enabled to give assistance to specific industries by extending credits, adjusting taxes, and helping with international trade problems.
The board could have as part of its machinery a credit agency modeled after the RFC of the 1930s. Any assistance it gave would have to be based on the principle of shared sacrifice. Labor would make its contribution through wages, benefits, and productivity; management through new investment, job security, and more efficient working conditions; creditors and investors through matching commitments to any RFC commitments. Trade, tax, and credit assistance would always be conditioned on appropriate contributions by all parties; and it would be temporary. An expert staff would consider the conditions under which specific industries could become more productive and competitive—if that is possible—and would provide guidance to the board. Not everyone would qualify for help; bail-outs for the inefficient are not part of the plan.2
I am opposed to government planning and to government-owned industries. I believe that the free market is usually the best market. However, the free market is not always adequate and not always right. The free market condemned New York, Lockheed, and Chrysler to bankruptcies that would have been extremely expensive, both in financial and human costs. Limited use of government credit assistance, extensive restructuring, and the cooperation of business and labor turned them into workable enterprises; but it would have been far better if a competent financing agency had been able to help them face realities earlier.
The cost of such programs need not be burdensome. An RFC could be set up with $5 billion of government capital. It could have the authority to borrow up to ten times its capital or up to $50 billion in the public markets. Its borrowings need not be guaranteed by the US government, whose investment would be limited to the initial $5 billion share capital. It could generate between $100 billion and $150 billion total investment, at least, by arranging for its own investment to be augmented with funds from the private sector. In a $3 trillion economy, this hardly amounts to socialism. The RFC, however, is only one of the instruments of national industrial policy; as I have suggested, adjustment of taxes and trade regulations would also be needed. The tripartite board would formulate such measures; and it could only do so in close collaboration with unions, management, and other groups. The president and the Congress would have to authorize all of its activities. Far from being undemocratic, the work of such a board could add to the democratic process an element of consultation with the major forces of our society.
An industrial and regional policy could work only if it were accompanied by sound fiscal and monetary arrangements; but it could, in ways not available to existing agencies, carry out a commitment by the government to help absorb the shocks of rapid adjustment and to maintain a fair social equilibrium. Too many countries successfully competing with us already have something like it. In the long run, a national industrial policy should, in my view, help us to adapt our training programs and even our education system to what we need. It must try to increase employment for inner-city minorities. It should revaluate the costs and possible trade-offs of fuller employment. We are going to have to consider plans for an earlier retirement age, for inner-city schools that will be more closely connected with job opportunities, and for some form of national service. Some of these ideas may not work; some may be too expensive. But we will have to consider many changes of the status quo; and to do so we will, in my view, need new mechanisms that will democratically bring together the major productive forces in the country and encourage them to work together. The challenge is not only to create more wealth for many, but to provide opportunity for all. This means adequate education and jobs available for those who seek them.
If I write with a sense of urgency it is because I fear that rising hopes and expectations at home are continuously encouraged by political promises that cannot be fulfilled. We do not have to bankrupt ourselves to maintain a rational balance of power with the Soviet Union and to protect our vital interests in Central America, the Middle East, Europe, or anywhere else. We are not going to war with the Soviet Union; if we are to talk of wars, we should think of the ones that have to be fought at home—against inferior education, racial discrimination, crumbling cities and dying industries, enormous disparities of wealth and privilege. These are struggles we can lose. If we do, the result would be a dangerous willingness to experiment with political extremism of the right or the left.
Today’s conservatism is an understandable reaction to the recent past, and some of its consequences may be healthy ones. Coherent alternatives to it have not been put forward, nor have the gloomiest predictions of bankruptcies and social strife come about. Merely criticizing the unfairness of current policies is not enough. Without realistic alternatives, “fairness” will simply become a code word for social programs and inflation we cannot afford.
If there is an alternative, it will be a policy committed to maintaining our social gains by promoting economic growth and full employment while able to deliver balanced budgets; a free-enterprise system that does not solely rely on the market to maintain its industrial and regional balance; and a government ready to lead the other Western nations in constructing an orderly financial system and a realistic and consistent foreign policy.
I am not so naive as to think that such a new approach is likely to emerge soon. It may not be feasible, but it should be tried. It would require four to eight years of a bipartisan administration in which a Republican or a Democratic president would include opposition leaders in his cabinet and would appoint a genuinely representative group to the kind of economic board I have suggested. When budgets have to be cut or long-standing expectations have to be revised, the blame will have to be widely shared. On a limited scale that is what the Municipal Assistance Corporation in New York was all about; whatever their shortcomings, the Greenspan and Scowcroft commissions can be seen as steps in the same direction.
Most of the traditional alternatives to the current trend toward conservatism have been discredited by the failures of the Carter administration, the serious economic problems of the French experiment, and the intellectual disgrace of the British Labour Party. The recovery may last, and if it does, the current philosophy of government is likely to prevail for some time. Indeed, if I am wrong and if we have long-term steady growth, the public will support such a philosophy for many years to come, and with good reason. But if I am right, we will face, sooner or later, a national debt of $2 trillion, a third world debt of $1 trillion, and an out-of-control budget, and our present domestic, social, and economic difficulties will become acute. At that point, something will have to change. The time may come for a new approach emphasizing bipartisanship, cooperation, and common sense.
August 18, 1983
A possible temporary measure, pending realignment of our currency, would be for the government to impose a variable tariff or tax which would be keyed to a “normalized” exchange rate. For instance, if we take 200 yen per dollar as a “normal” rate, the tariff or tax would be zero if the rate is 200 and would move up to 20 percent if the rate is 240. This would obviously not be limited to the yen but would apply to all major currencies that are significantly out of line with the dollar. Such an arrangement is clearly not perfect; it would be far better to have international agreements with respect to main currency values. But it would be better than legislation specifying that products must have “local content” or other permanent trade barriers. It would also eliminate the need for such current arrangements as the so-called “voluntary” restraint agreement on automobiles. In the 1960s we enacted an “interest equalization tax” to improve our balance of payments; what I am suggesting is an “exchange equalization tax.” ↩
Some would also argue that, for political and practical reasons, a National Economic Board and a new RFC should be limited to industrial investment and should not, as I would suggest, also invest in regional development, including such public facilities as mass transit and harbors. They could be right, but such issues should be debated. ↩