Facing Up: How to Rescue the Economy from Crushing Debt and Restore the American Dream.

Peter G. Peterson is a former cabinet member in the Nixon administration and the kind of conservative who, with the ascendancy of the New Right, has been largely displaced in the Republican party's leadership. Wanting to preserve the United States' well-being, he watched in horror as crackpot economic nostrums, dressed up as "supply-side economics," let the country's "infrastructure crumble, its productivity dwindle, its savings evaporate, and its budget and borrowing burgeon." He writes that as "the mad drunken bash was on in Washington and the debt party grew more careless and frenzied with each passing day," he became persona non grata at the Republican White House. Gradually he drifted into political opposition concerned "about mounting U.S. deficits, dwindling savings and investment, and slow productivity growth--as well as the huge bill for our present consumption we were leaving to our children and grandchildren."

What fundamentally motivates Peterson's book is the country's lagging productivity performance. In two of the handsomely produced charts which constitute an appendix to this book, Peterson shows that U.S. productivity growth has, since the early 1970s, seriously lagged behind both the advanced countries of the world and our own historical experience. This lag accounts for the stagnation in household incomes experienced over this same time period. Peterson is motivated to restore the economic security of the people of the country by reinvigorating the economy's rate of productivity and technological growth.

Peterson's strategy to restore economic health to the country is to reduce the federal budgetary deficit by the beginning of the twenty-first century, while at the same time increasing the level of government investment in infrastructure. To do so he proposes an increase of $320 billion in taxes and reductions of $288 billion in government expenditures. Among the latter are substantial decreases in entitlement expenditures, largely accomplished by cutting benefits for households with above median incomes. In addition, Peterson would raise revenue by taxing entitlement benefits, would institute a rise in the Social Security retirement age, cut defense spending and discretionary expenditures, and introduce a variety of schemes to curb governmental healthcare spending, while at the same time extending health-care insurance to the uninsured. Finally, the largest single source of savings would be the interest payments which the government would no longer be required to pay, amounting to $282 billion by the year 2004.

Peterson believes that a reduction in entitlement programs can be implemented without putting at risk the well-being of the poor. This is so because he calculates that more than 50 percent of government entitlements went to households earning more than $30,000. This may be true, but Peterson is not really convincing that cuts to the middle class can be done without harming households which are in genuine need. In defense of his program he is very critical of the economist Alicia H. Munnell. She defends extending benefits to the nonpoor on the grounds that only in doing so could the poor be sure to obtain the help they needed. In response to Munnell's argument that "programs for the poor tend to be poor programs," Peterson writes "this is stunning. Benefits to the elderly poor are, as they should be, sacrosanct." But eighteen pages earlier, Peterson provides evidence in support of Munnell's argument, and thereby undermines the validity of his own, in pointing out that "inevitably, those who needed the public help the most--especially the poor and the young--were not so adept at pushing to the front of the line." If this is the case, then the kind of cuts envisioned in this volume can hardly be expected to exempt the poor.

But the real problem with Peterson's approach lies not in this kind of political misjudgment. Rather it lies in his economics, and specifically in his single-minded commitment to the belief that increasing savings by reducing the budget deficit is the key to the restoration of rapid productivity growth. The analytic pivot for his policy prescription is his "rule of thumb" that a 1-percent increment in productivity will require an increase in investment of 6 to 8 percent of gross domestic product (GDP). Since a government deficit reduces the savings available for investment, Peterson reasons that the goal of raising productivity growth can be achieved by eliminating that deficit and using all of that money in new investment.

Simply put, Peterson's confidence that increasing the pool of savings in this way will accelerate productivity growth is unwarranted. In a book full of data, it is striking that one important and easily obtained data set is not mentioned at all. That is, during the years of U.S. productivity decline, investment did not fall at all. Throughout the 1970s and 1980s, gross private investment as a share of GDP hovered at around 17 percent with no tendency to fall until the early 1990s. It is true that a substantial fraction of this investment was financed by overseas savers. But whatever the source of its financing, declining investment was not the reason for falling productivity growth rates. Peterson's strategy, to accelerate productivity growth by increasing investment, is not directed to the right disease.

Further, Peterson gives us no reason at all to believe that the vast increase in savings which a massive reduction in the deficit would produce will find productive outlets. As a result, he is much too cavalier in considering the issue which motivated Keynes in the 1930s. The risk is that by reducing consumption in the name of increasing savings, the economy will go into a downward spiral caused by declining consumption. In this case, what the government does not spend, if not made up by an increase in investment, could well trigger falling production and employment.

Peterson offers a program that is unacceptable because the risks associated with it far outweigh its likelihood of success. Unleashing a massive deficit-cutting program could further overwhelm the poor, trigger a recession or worse, and still not solve the productivity problem. We do need a strategy which will accelerate productivity growth. But it will have to be more nuanced than Peterson's in simultaneously addressing the needs of the poor and the economy.