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Clintonomics: what's it going to be?

Is the new president rethinking federalism, and will there be a new "productivity agenda" for the states?

As a new administration gets under way and debate over its first budget proposal begins, many wonder what is in store for federal fiscal policy. What principles will govern the economic policies of the Clinton administration?

In 1961 the Kennedy administration placed the policy levers in the control of young economists schooled in the principles of Keynesian demand management policy. They put this theory into practice with a set of tax cuts to "get the country moving again."

In 1981 the Reagan administration adopted the philosophy of the "supply-siders" who prescribed sharp cuts in marginal tax rates to boost business investment and growth and increase government revenues. "Reaganomics" came to mean supply-side theory put into practice.

There is considerable reason to think that Clinton, who campaigned as a "new kind of Democrat," has been influenced by a new wave of thinking about economic policy. This philosophy, if it should become the guiding principle of "Clintonomics," would have substantial implications for the next chapter in federalism.

The new approach calls for increased public investment to rejuvenate the American economy. Notably, proponents pay less attention to the current recession, and focus more on the failure of the economy to maintain rising living standards since the early '70s. In contrast to some of the "small is beautiful" thinking of the '70s, the new school is pro-growth.

These ideas have been championed by the Economic Policy Institute, a liberal think tank based in Washington, D.C. A founding member of the EPI board of directors is the new Secretary of Labor Robert Reich, a longtime Clinton confidante who headed up economic policy for the transition team.

In some respects, the new public investment advocates of the center-left have more in common with the supplysiders of 12 years ago than with earlier liberal economic proponents. In particular, their approach is more micro-economic than macro-economic. While its tenets are by no means universally accepted--any more than the supplysiders were--the new approach has received widespread currency, and its proponents seem to have the attention of the new administration.

The conventional theory of fiscal policy calls for increasing government spending or cutting taxes during slumps to increase the demand for goods and services. The economy is seen as a stalled engine that needs to be restarted. Deficits can be tolerated temporarily to "prime the pump" and get the economy going again. Similarly, the prescription for an economy that has become "overheated" calls for the government to run a surplus to suppress demand and thus combat inflation. This is known as "stabilization policy;" its goal is to iron out the business cycle, eliminating (or at least moderating) the short-run bumps in the road encountered by modern capitalist economies.

Since its formulation by the British economist John Maynard Keynes in the 1930s, "demand management theory" has dominated national economic policymaking in the industrialized world. The theory grew in prestige when it seemed that the Kennedy administration had demonstrated that economists could "fine tune" the economy. Control of a few macro-economic levers (government spending, revenues, interest rates) was sufficient to maintain a stable, robust economy. All that fell apart in the late '60s and early '70s with a series of shocks. President Johnson attempted to have both "guns and butter," financing the war in Vietnam and the Great Society and destabilizing fiscal policy in the process. Then came the oil crisis and President Nixon's wage and price controls, and by the mid-1970s the U.S. economy was mired in "stagflation"--the simultaneous presence of both inflation and high unemployment--which Keynesian fiscal policy was ill-suited to address. Furthermore, in the 1980s the U.S. economy became more integrated with the world economy, which greatly diminished the effectiveness of demand management tools.

The focus of the new school is not on "stimulus" or "pump-priming," but on investments intended to enhance the growth of productivity. A report by the Jerome Levy Economics Institute at Bard College (a center of this new thinking) calls for "more reliance on public investment as a fiscal stimulus and less on deficit-financed public consumption."

The new thinking is in part a response to the growth puzzle of the last two decades. Economists have struggled to find a satisfactory answer to the question: "Why did the historic growth of the post-World War II U.S. economy sputter in the early '70s?" No completely satisfactory explanation has ever been advanced, but the most popularly accepted culprit is inadequate savings and investment.

In the late 1980s, economist David Alan Aschauer, now a professor at Bates College in Maine, offered a new twist on this line of thinking. He argues that the decline in growth is the result of inadequate public investment, specifically a slowdown in infrastructure spending over the last quarter century, which he calls "America's Third Deficit." Whereas supply-side theory argued that economic growth was impeded by high taxes, Aschauer's argument suggests that insufficient government spending held back the economy.

The key to his analysis is the way public and private spending interact. Aschauer points out that growth depends on public as well as private investment. For instance, a factory will not be built if there is not an adequate transportation network to deliver raw materials and distribute final products. As a more specific example, Aschauer cites the implementation of "just-in-time" inventory control, an innovation that seems to be raising productivity in some areas of manufacturing, but is heavily dependent on efficient transportation.

Aschauer's approach represents a real departure from the conventional treatment, under which there is a tradeoff between government spending and investment. An increase in government spending is assumed to "crowd out" private investment, by raising interest rates. Aschauer argues that public investment can "crowd in" private investment as well. He further contends that at the present time investment in public capital should take precedence over investment in private capital, because the former may have four times the impact on the economy.

The initial response to Aschauer's thesis ranged from polite skepticism to outright derision. Conceding his basic reasoning, some argued that Aschauer "got the sign right, but overstated the magnitude." In other words, he may have correctly identified an effect, but he exaggerated its size and importance. However, a series of empirical studies, including some performed by skeptics, lends support in the hypothesis. Some researchers got even more dramatic results.

Among centrists in the economic community, a similar line of argument has gained adherents. Although there are strong differences with Aschauer on certain aspects of policy, the writings of those advocating an activist approach to economic policy reflect a similar orientation toward public investment. Perhaps none is more important than Alice Rivlin, now deputy director of the Office of Management and Budget.

The founding director of the Congressional Budget Office, Rivlin spent the last several years as a fellow at the Brookings Institution, rethinking the state of the U.S. economy and the role of federalism. Her 1992 book Reviving the American Dream: The Economy, the States & the Federal Government, combines her strong belief in the need to reduce the federal deficit with an argument for greater public investment in infrastructure (roads, bridges, mass transit, wastewater treatment facilities) and human capital (education, employment and training). Moreover, Rivlin calls for the states to "take primary responsibility for a productivity agenda involving education, workforce skills and public infrastructure, while the federal government should retreat from those areas." To many, this echoes President Reagan's call for a "new federalism"--a grand swap of responsibilities between the federal government and the states. Many liberals opposed the idea because they saw it as a plan to scale back government at all levels. Rivlin's support for sorting out which responsibilities belong to the states and which belong to the federal government, however, derives in part from her belief that a lack of "clarity" in the roles of different levels of government contributes to the unwillingness of voters to support taxes adequate to finance the government services they expect.

The notion of increased public investment as a growth and productivity strategy has received support from economists of otherwise disparate viewpoints. Nonetheless, there are some important differences among them on many details. A significant difference between Rivlin and some of the more ambitious proponents for higher public investment is how they see the importance of reducing the deficit. In stressing the need for increased public investment, Aschauer deemphasizes deficit reduction. For Rivlin they go together: deficit reduction is necessary to accommodate private investment; increased funds are necessary at the state level to accommodate public investment. Since Aschauer believes the return on public investment is much higher than that on private, he is less concerned about balancing the budget.

The appeal of the Aschauer thesis is far from universal. Many economists still sharply disagree with the notion of an "infrastructure gap," and dispute whether the return to public capital is higher than private. Critics of the thesis can point to the assertion of the Congressional Budget Office that there is "little evidence to suggest that substantial across-the-board increases in current public capital programs would have a marked effect on economic output."

One thing is clear. If increased public investment in infrastructure becomes the focus of federal economic policy, we are on the brink of a new, new federalism. Precisely how states will be affected is not so clear. Would this mean more federal aid to the states? Would it mean new revenue authority for states? Or would it mean a federal takeover of traditional state functions?

An important question is how new spending on public investments would be financed. One possibility is that reductions in defense or lower-priority domestic spending could be used to fund grants to state and local governments. Another option would be to dedicate a new source of revenue to funding such grants. Finally, a new source of revenue could be made available to states so that they could finance activities on their own.

The first option is the simplest and easiest politically, but it may not provide a great deal of money. Defense spending has already been reduced, and further savings may be limited. Moreover, a Democratic president may find it difficult to make any significant reductions in social services for the poor, and middle-class entitlements are notoriously resistant to change.

A new federal tax could provide funds. Much speculation centers on a value-added tax, which most industrialized countries use. The VAT has many advocates among those who believe that the goal of economic policy must be to increase national savings. The primary arguments against a VAT are that it is regressive, and that it would harm state fiscal systems by encroaching on their most important revenue base.

A third approach, which is discussed by Rivlin, is that new collective or common taxes could be levied and administered by the states. The new tax would logically be a consumption tax, such as a VAT. The new tax could then supplant existing state taxes, i.e., the sales tax. The common tax could be imposed by Congress, or it could be initiated by the states themselves, through compact. At first, a small number of states might join together, establishing a common base and administrative procedures, with a single agency for businesses to deal with. This would simplify compliance, perhaps enhancing state and U.S. competitiveness in the global economy.

Will this new emphasis on public investment provide the underpinning for the economic policies of the Clinton administration? Several clues indicate that it could.

Clinton eschewed traditional demand management policy both during the campaign and the transition. He specifically rejected the idea that the only way to stimulate the economy is by increasing the deficit. He spoke of a need for "strategic investment," and focused on productivity and long-term growth. He has repeatedly referred to the decline in U.S. productivity growth since 1973.

His choice of Laura D'Andrea Tyson to chair the Council of Economic Advisers is significant not just because he passed over economists of greater national and international prominence. In choosing Tyson, Clinton broke with the conventional wisdom that the job should be filled by someone with a reputation as a macro-economic forecaster, and opted for someone with a micro-economic orientation.

His choice of Robert Reich for the transition team and then as secretary of labor is noteworthy because of Reich's ties to the Economic Policy Institute which actively supports Aschauer's public investment analysis.

And of course, he chose Alice Rivlin for the OMB post. How many of the ideas expressed in her book will actually find their way into administration policy remains to be seen, but as a former governor, President Clinton might be sympathetic to her ideas for strengthening the role of the states within the federal system.

Time will tell if the Aschauer thesis is the key to restoring American economic prosperity, or just another misguided economic theory.

And, as the outlines of Clinton economic policy begin to emerge, we will see whether it will reflect the thinking of Aschauer, Rivlin and others in urging a shift toward greater public investment and greater reliance upon the states.

Christopher Zimmerman is NCSL's chief economist.
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Title Annotation:Pres Bill Clinton's economic policy
Author:Zimmerman, Christopher
Publication:State Legislatures
Article Type:Cover Story
Date:Mar 1, 1993
Previous Article:Federalism at a crossroads.
Next Article:Federal entitlement reform and the states.

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