Bread, butter & infrastructure: economic issues in the campaign.

The 1992 presidential campaign may never provide us with a genuine debate about the state of the American economy. What we have seen so far in the campaign is sometimes a slugging match, sometimes a battle of sound bites; rarely does it resemble a true argument. Whichever side is more responsible for the poor quality of the dialogue, the result is that voters will have to decode the rhetoric of the campaigns for themselves, and decide which, if either, offers hope. This two-part article is offered as a resource in that effort. (The first part appeared in Commonweal, June 19, 1992.)

The place to begin is with the nature of capitalist economies. It is undisputed that they have been successful in producing unprecedented amounts of goods and services. It is equally clear that capitalist growth has proceeded unevenly between countries and within regions, creating great disparities of wealth and income, and that it has always proceeded cyclically, through euphoric booms and painful busts in every country and region.

Capitalism, wrote the great twentieth-century economist Joseph Schumpeter, is characterized by "creative destruction." Market-driven capitalism creates new technologies, new methods of organizing production, new jobs, new consumer goods. But a cost is exacted, imposed unequally on different countries, groups, regions, and families. New systems, technologies, products result in the destruction or displacement of existing ones. For one current example, closing or relocation of plants destroys jobs here and now, hurting specific families and communities.

Can governmental policies hold the destructive side of capitalism in check while encouraging its creative side? If so, how? That is where disagreement enters. Without attempting to do full justice to all viewpoints, I will offer some answers that make sense to me as an economist. For the most part, I will focus on policies that are necessary for long-run improvement of the economy, and will then assess the economic policies recommended by President George Bush and Governor Bill Clinton within that framework. As will be evident in my comments, the Clinton approach - while still unclear and certainly incomplete - appears both more comprehensive and better adapted to the economic realities than the president's.

Short-term policies. For the immediate and near-term future, available measures to overcome the present recession include action by the Federal Reserve to stimulate investment by maintaining low interest rates, and new kinds of government spending - for example, block grants to the states for infrastructure investment - to increase short-run demand. Such investment would also aid productivity growth for the long run. In contrast, the use of tax cuts as a quick fix for low demand is the opposite of what will be needed over the longer term - and temporary tax cuts have a way of becoming permanent.

Appraisal. Both candidates appear to favor low interest rates. Clinton speaks often of new government investment for improving the infrastructure and related needs, whereas Bush continues to rely for stimulus on reducing capital gains taxes and now speaks of an across-the-board reduction of taxes conditioned on decreases in federal spending.

Long-range Conditions

There are two problems of long-range significance for the U.S. economy. First is the increased competitiveness of other countries in the international economy, which has eroded the dominant position of the United States. Second are the government policies pursued during the 1980s in the name of free enterprise - tax cuts, heavy military spending, and lowered public investment. The results of our loss of international hegemony combined with the inappropriate policy responses of the 1980s have been a decline in U.S. manufacturing with a consequent loss of many high-wage jobs and the appearance of a two-tiered wage system; increases in income inequality, poverty, and homelessness; a huge rise in the federal deficit; and a shift from trade surpluses to trade deficits.

The global economy. The causes of the decline in U.S. competitiveness are less easily captured. First, it's necessary to understand how the world economy differs from that of any individual nation. In every domestic economy a central government having sovereign power establishes the framework and rules for carrying on economic exchange. In the United States, the federal government has the power under the Constitution to regulate interstate commerce. No state can impose import tariffs on goods produced in other states. The central government sets minimum wages, environmental regulations, safety requirements, and other economic parameters that are binding on all states, thereby creating what is now a continent-wide market, within which the creative side of capitalism is able to display its powers, and its destructive tendencies can be reined in, given the political will to do so.

There is no central government in the world economy to set the rules, though for much of the modern era there have been partial substitutes. Prior to World War I Great Britain more or less dominated and regulated world trade, but during the interwar years Britain was too weak and the result was chaos in the international economy and depression in the industrial countries. After World War II, world leaders at the Bretton Woods conference created institutions capable of regulating world trade to some extent. Exchange rates were fixed, resources were made available to countries in need of investment, temporary adjustment loans were made to nations experiencing international payments difficulties. The system worked, though hardly perfectly, because of U.S. dominance of the world economy. Few would claim that world trade became equitable, but for almost thirty years the system fostered stability. The recovery of Europe and the acceleration of economic growth in parts of the third world were two outcomes of our leadership.

President Richard Nixon's 1971 decision to let the dollar float reflected both the loss of U.S. economic dominance and the weakening of the Bretton Woods system. Today a new situation prevails. Japan, Germany, and others rebuilt their economies after the war with the latest technologies, giving them a more up-to-date industrial structure than the U.S. The process was speeded up as countries like South Korea and Taiwan began to industrialize, combining state-of-the-art technology with exceptionally low wage levels, creating ever stronger competition in the world marketplace.

Moreover, despite lip service paid to the principles of free trade, the economies that rebuilt after World War 11 did so with substantial protection against foreign competition. They all protected their farmers and used various means, tariff and non-tariff, to protect selected industrial products. For example, through the 1960s Japan imposed formal tariff and nontariff barriers against foreign competition while building a highly centralized economy based on networks of banks and firms. When Japan reduced formal trade barriers, largely in response to pressure from abroad, these firms continued to buy from one another even when foreign products were cheaper. The Japanese assumption was that increased market share and long-term profits, aided by the survival of the networks, were more important than the supposed benefits of global free trade. Tariff reductions, then, have different effects in Japan than in the U.S., and the result has been tremendous Japanese trade surpluses.

With the warning of U.S. power and the decay of the Bretton Woods system, coordination in the international economy has been largely absent. Economic "summits" have tried to reestablish coordination, but it is difficult to reconcile the differing national economic interests involved. For one example, the German use of high interest rates to fight inflation has had the effect of reducing imports from the United States and other countries, thereby contributing to their sluggish economic growth.

Efforts to organize the world economy on pure free-market principles - mainly by preachment - have not been successful. World economic growth has slowed; in many areas of Africa and Latin America growth actually became negative during the 1980s. Trade imbalances have become extreme. Instability of exchange rates has become endemic in many areas. And the foreign debt borne by many countries, now including the United States, can only have a severe constricting effect for years.

What is to be done? New international agreements are needed if restructuring of the international economy is to be successful and achieved with minimum conflict. The world needs more stability, and it can be achieved only by conscious and coordinated planning and action. The place to begin is to deal with the debts of third-world countries in a way that will allow them to resume growth (which will increase demand for our exports). This may require some form of debt forgiveness. The Europeans and especially the Japanese are leading in this area.

Next we must attempt to move back to more stable exchange rates by reaching international agreements on ranges of rates and mechanisms to support them. This will work only if we begin to deal with international capital flows, making them less fluid by regulating them and beginning to tax them. From the perspective of the common good, the point of enabling flows of capital is to make capital available where it can contribute most to production; in the absence of regulation, capital moves for speculative and financial reasons that often have little to do with productivity, not to speak of equity or equality.

The same consideration applies to individual national policies regarding exchange rates, trade, and debt issues: all will be more effective if set within supranational programs that encourage and coordinate them. Just as it has been necessary for all countries to exert control over the workings of their domestic economies for the common good, it is time to extend similar measures to the international economy. The very factor that makes governments reluctant to cooperate - significant levels of unemployment at the domestic level - can be confronted only by a coordination of macroeconomic policies. We cannot continue to practice one kind of economics up to our frontiers and another kind beyond them. The solution will be endlessly complex but a start must be made. As a very long-run goal, the U.S. should lead the other concerned nations in setting up, through the United Nations and regional bodies, an institutional equivalent of a world public sector with authority to bring about international coordination of national economic policies.

Appraisal. To an extent the Bush administration has dealt with the problem of third-world debt, through the Brady plan, but much more needs to be done. The president has also entered into agreements to support the dollar. In general, however, Bush relies on the workings of the free market to provide international coordination. Clinton's economic plan (discussed below under "Interim Steps") shows some recognition of how lack of regulation and coordination in the international economy affects the U.S. But much remains unclear. Bush proposed and Clinton has tentatively endorsed the recently negotiated North American Free Trade Accord, but it remains to be seen whether the accord is simply an extension of mostly unregulated free trade throughout the continent or the kind of needed coordination discussed above. If it turns out to be basically a free trade agreement, it may bring somewhat lower consumer prices while putting jobs, social benefits, and the environment (ours and the world's) at risk.

Interim Steps

The new international agreements discussed above may appear - at least to candidates - too visionary even to be broached in a campaign dominated by catch phrases and personal attacks. But there are ways in which the U.S. can act more or less unilaterally, without compromising the long-term goal of international economic coordination and without embracing knee-jerk protectionism, by pursuing policies for a world in which most countries utilize a combination of partial openness where it benefits them, and subsidies, export promotion, and import restrictions in other areas. Among those worth discussing:

Imposition of a "Vat-corrective" tariff. Value-added Taxes (VATS) are excise tolls imposed on the increase in a product's value created at each stage of its production and distribution. Most industrial and newly industrializing countries derive some of their revenue from VATS in the 12 to 15 percent range, but waive them on exports, in effect subsidizing exports. The U.S. could impose a Vat-corrective tariff equal to the exporting country's domestic VAT. Other penalties and surcharges should be held in readiness to discourage - preferably through negotiation - cases of subsidies, dumping, discounting, and other flagrant abuses of import and export controls.

Protection of our standards. Other countries have different policies toward certain issues that affect international price levels: e.g., child labor, a minimum wage, environmental standards, antitrust regulation, social security, and unemployment benefits. A country without such policies has lower production costs and can charge lower prices than the United States. A simple free trade policy places enormous pressure on the United States to undermine these social regulations, as is demonstrated by the efforts of the President's Competitiveness Council to soften environmental regulations. Instead of letting the lowest standards rule, offsetting tariffs are needed.

A strategic trade policy. Japan, Korea, and many European countries that do not have our simple faith in free trade follow policies that try to create comparative advantages in key industries such as the Airbus in Europe or supercomputers, optical fibers, and biotechnology in Japan. If we want vibrant steel, electronics, or biotechnology industries rather than whatever the marketplace gives us, a strategic trade policy needs to be developed. This is where government helps create the conditions for "winners" - that is, industries of the future that will make us more competitive with other countries - to be born and to thrive. It creates the conditions by investing in education, subsidizing basic research, and helping to finance promising new technologies. If done well such a policy could keep us from falling hopelessly behind other countries, and it could put pressure on them to open up their economies.

It's true that an industrial policy poses a danger of hiding inefficiencies by restricting competition, but that risk should be balanced against the high costs of relying only on free trade (failed businesses, lost jobs, destroyed communities, abandoned schools, neglected infrastructure). Another danger is that of tit-for-tat responses from other countries that could reduce the welfare of all, a risk that can be lessened through negotiation, since every country has industries it wants to maintain or develop.

Trade readjustment assistance. Finally, despite the above policies, there will still be many industries that are hurt by international competition. To soften the human suffering in those cases of massive dislocation, trade readjustment aid needs to be increased. Retraining programs for displaced workers, relocation allowances, and subsidies to impacted communities to attract new businesses are needed to help reduce human suffering and increase economic efficiency by providing access to new skills and encouraging mobility of resources.

The key issue here is that worker retraining and relocation, community investment, and other policies are necessary if we want to manage the transition to the new world economic order that is in the making. Similar transitions in the past were, by default, paid for by the people and communities left behind by the creative-destructive changes brought about by capitalist development.

Appraisal. Bush has rejected proposals for astrategic trade policy and calls instead for reliance on the workings of the free market, coupled with arm-twisting of our trading partners in specific cases. Shortly after the Republican convention, in an interesting departure from avowed policy, the National Institutes of Health issued a draft of a broad strategic plan to set priorities for the government's vast biomedical research support. For the first time these government research funds are to be evaluated not only by their impact on the nation's health, but also by their "contributions to the enhancement of the nation's economic growth, productivity, and competitiveness." One goal appears to be the encouragement of the biotechnology industry, which had sales of $4 billion in 1991 and projected sales of $50 billion by the turn of the century. This is exactly the type of program that would be part of a strategic trade policy.

Programs offered by Clinton do add up to a strategic trade policy. He proposes creating a "civilian research and development agency to bring together businesses and universities to develop cutting-edge products and technologies"; the agency would focus on "crucial new industries such as biotechnology, robotics, high-speed computing, and environmental technology." He also proposes creating an "Economic Security Council" (paralleling the National Security Council) "with responsibility +for coordinating America's international economic policy." His administration, he has said, would urge our trading partners to abandon unfair trade practices; "if other countries refuse to play by our trade rules," he has said, "we'll play by theirs." Clinton's economic plan also contains a program for retraining workers that is to be financed by a small increase in payroll taxes. After the Republican convention, in response to Clinton's plan, Bush proposed a $2 billion-a-year retraining program to be financed from unspecified expenditure cuts.

Domestic Policy

In a competitive world, international and domestic economic policies are inextricably linked. Restoring economic growth in the U.S. will require us to increase national savings by reducing the chronic federal budget deficit, to increase productivity through public investment in human capital and infrastructure, and to pursue a full-employment policy.

The deficit, growth, taxes. One approach to deficit reduction is to rely on economic growth to increase tax revenues. The stagnation of the past four years has held back growth in income and therefore in tax revenues. Unless there is a triple-dip recession, the normal expectation is that there should be three or four years of better economic growth beginning next year - enough, according to an estimate by the Congressional Budget Office, to reduce the deficit by one-third to $193 billion in 1996. To promote further growth, Bush relies on capital-gains tax cuts, Clinton on government investment.

But there is a chicken-egg problem: economic growth is needed to lower the deficit, but the deficit needs to be reduced to increase economic growth. Though control of expenditures can make a contribution (of this, more below), neither spending cuts nor "natural" growth nor both together can of themselves reduce the deficit enough to finance the needed investment. It follows that tax increases are also needed. In economic terms, the deficits resulting from the ill-advised tax cuts of the early '80s are dis-savings; they have lowered the total national savings available to finance long-term investment in the economy, the source of productivity gains and economic growth. As explained in the first installment of this article, our reliance on foreign savings for domestic investment has served to increase the trade deficit.

The two arguments against raising taxes are that we are already overburdened and that more taxes will reduce incentives to save, invest, and work. In fact, the evidence available supports neither contention. The U.S. has the lowest rate of taxes (federal, state, and local) out of income among the major industrial countries - 30 percent compared to an average of 45 percent for Europe. Thus, the excessive burden argument against tax increases is unpersuasive.

What about the argument that high taxes have disincentive effects that slow economic growth? When economic growth over the period 1980-1987 for fourteen industrial countries is compared to tax rates there simply is no relationship. Some high tax countries grew rapidly, others slowly. So also for (relatively) low tax countries.

Why do Americans resist taxes more than others? The major reason for our low tax rates is a matter of our political culture: Americans have always been more suspicious of government than most Europeans. President Ronald Reagan, who had his own visceral-ideological distrust of government, played on that suspicion to convince the public that taxes were too high and government spending wasteful. As Walter Mondale, Paul Tsongas, and Ross Perot learned, a politican running for office who advocates more taxes takes an enormous risk.

Appraisal. Bush not only opposes any tax increases but, as we have seen, strongly urges a reduction of capital-gains taxes. A study of the capital-gains tax proposal by the Joint Committee on Taxation concluded that nearly 70 percent of the tax reduction would go to those with incomes over $100,000 a year. The Bush claim that these tax reductions would be saved and channeled into investment, leading to more growth and more jobs, and thus to increased tax revenue and a lower deficit, does not square with the experience of the past twelve years under the same policy. At the Republican convention, Bush added an across-the-board tax cut, of unspecified amount, to be paid for by unspecified expenditure reductions. It's hard to believe this is anything more than a political gambit to pacify the supply siders in his party.

Clinton has proposed some modest tax increases on the wealthy, expected to bring in $80 billion in tax receipts over the next four years, and a closing of tax loopholes for corporations for another $60 billion. His program also contains tax reductions: expansion of the earned income tax credit, a choice for the middle class between a children's tax credit and a "significant" reduction in income tax rates, a targeted investment tax credit, and a 50 percent tax exclusion for small businesses making long-term investments in new businesses. How much tax revenue would be lost through these reductions is not clear. What is clear is that neither the Bush nor the Clinton proposals would significantly reduce the deficit.

Alternatives. From the viewpoint of an economist concerned for the common good, there are other ways to go that ought to be part of the political dialogue. One of them is adoption of a VAT system for the U.S. It has been calculated that such a tax could eliminate the deficit and cover the costs of rebuilding infrastructure, upgrading education, and extending medical coverage to all. Exempting basics (food, housing, medical care) would reduce the regressivity inherent in any excise tax. Income taxes could be reduced as an incentive to accept a new VAT. It would be easy to share the VAT revenues with states and local governments to carry out needed programs. An added advantage is that the tax would fall on consumption rather than income, thereby providing an incentive for savings.

Increased taxation of gasoline could raise additional tax revenues and encourage conservation in its use. Our gasoline prices are the lowest among industrial countries and, in real terms, not much higher than they were before the 1973 oil crisis. Higher "sin" taxes also make sense. Real tax rates (adjusted for inflation) have fallen to half the 1950 rates on cigarettes and to 25 percent on alcohol. For a final example, a good case can be made for a securities transfer excise tax; it could raise some $ 10 billion a year in revenue and it would discourage dubious short-term, speculative practices while fostering a more stable supply of long-run capital funds.

Cost-cutting. Bodi Bush and Clinton have proposals to control spending on certain government entitlement programs. At least on paper, the Bush plan would hold down costs much more than Clinton's. The president would set overall ceilings on entitlement expenditures and impose specific reforms such as requiring wealthier recipients to pay higher monthly Medicare premiums, for an overall saving of $68 billion over the next six years. In Clinton's projected budget, entitlement reform is relied upon to save $4.4 billion over four years. (This does not include any savings from an overhaul of the health-care system, which is still in the making.) On military spending, the Clinton plan for defense funding calls for $38 billion more in cuts over the next four years than the Bush program.

When we look at the federal budget there are three expenditure items, about $250-300 billion each, that dwarf all the others - social Security, interest payments on the national debt, and military expenditures. Interest payments are legal obligations, Social Security appears politically untouchable at this time, and there are real limits to military reductions. Thus, the belief that expenditure reductions alone can substantially lower the deficit is false.

Investment for growth. Reducing the deficit will increase national savings to finance more private investment. But we must also invest in human beings and infrastructure, both neglected for twenty years, to make that private investment more productive.

If improving the quality of the workforce is obviously vital, how to do it is less clear. For example, take the issue of improving education. Research studies have been unable to find any relationship between resource inputs and indicators of success such as achievement test scores. Simply spending more on schooling is not promising; we need to know more about what works and what doesn't. Evidence suggests that money for inner-city schools that lack textbooks and lab facilities is effective; so also for Head Start programs and vocational training. It may well be that more basic change is needed, but we do not know what type of structural change will help. President Bush's voucher plan night work, or it might make schools even more unequal; there is little hard evidence either way.

So also with infrastructure: empirical studies disagree over how much such investment will increase productivity. Some argue instead for more efficient usage. If heavy trucks were charged in proportion to the damage they cause highways, for example, more freight would be shifted to railroads, reducing both the irksomeness and the economic costs of traffic congestion. Still, it is clear that many of our roads, bridges, and inner cities are decaying, and that investment in infrastructure creates jobs and induces technical change. The key issue is choosing those projects that have the highest pay-off, rather than those pushed by the strongest lobbies; a choice that will take presidential and congressional leadership.

Appraisal. If one assumes effective action against the deficit, Clinton's proposal to increase public investment in infrastructure and human capital by $200 billion over the next four years is a more direct and equitable way to improve productivity than Bush's emphasis on capital-gains tax cuts, an educational voucher system, and further deregulation of business. Apart from roads and bridges, investment in railroads, information networks, environmental technology, defense conversion, worker retraining, Head Start, apprenticeship training, and a national health-care plan should, despite the problems noted above, enhance the productivity of private capital.

Full employment. A key structural problem of a free market economy is its inability to cope with unemployment. The reason it exists is that in our economy a majority own no land, production-scale tools, or capital, and have only their labor to sell. The minority who own these assets hire or retain employees only when it appears sufficiently profitable, so that employment is a byproduct of profit-making and therefore subject to the vagaries of the business cycle. Thus a minimally regulated market economy will seldom if ever generate full employment. Among measures that would move us toward the goal of full employment:

* A public employment program, possibly linked to infrastructure repairs and improvements as well as other areas of needed public service.

* More consultation among the main economic actors - industry, agriculture, labor, and all levels of government - to implement the goals of the under-utilized Employment Act of 1946, working through committees with the Council of Economic Advisers. Policies that might emerge from these consultations include targeted job programs, education and training to equip workers with needed skills, day care centers for employed parents, and so on.

Appraisal. On form-that is, judging by the record and his public statements - governmental intervention on this scale and for these purposes is anathema to Bush. Clinton's economic plan includes a national apprenticeship program, a youth opportunity corps, worker retraining programs, and a plan to move people from welfare to work through education, training, and child care. These programs aim at reducing unemployment but do not include any central coordinating body to insure that they add up to a full employment guarantee.

Summary

The economic problems that confront the American people are real and extremely serious. In the near term, it is proper for the U.S. to insist on fair terms of trade while holding to the ideal of a free trade world regulated by new international agreements.

Domestically, we need policies deliberately aimed at overcoming stagnation and promoting equitable and sustainable growth, while protecting the environment. It must be emphasized that we cannot achieve any of these goals nor can we contribute to global economic stability as long as we suffer from the fiscal constraints imposed by the trade and federal budget deficits.

Many Americans are already convinced, and correctly so, that there are no painless solutions. But practically all workable programs will meet opposition from powerful special interests; moreover, they must be enacted and carried out in the context of deep philosophic differences among the American people: free markets vs. government intervention, individual freedom and responsibility vs. community obligations, and so on. These differences, along with serious conflicts of interests, will also hinder efforts to restore and enhance international economic relationships.

The times, in short, demand real political leadership. We must expect and require it of our representatives.

CHARLES K. WILBER is a professor of economics at the University of Notre Dame. He is co-author with Kenneth P. Jameson of Beyond Reaganomics: A Further Inquiry into the Poverty of Economics (University of Notre Dame Press). Part I of this article appeared in the June 19, 1992 issue.