Economic growth and policy in the nineties.
economic growth in 1992-96 of 3 1/4 percent a
year. The determinants of long-run growth
are demographics and productivity. Both of
these can be influenced by public policy. A
long-term approach is needed to economic
policies that reward private initiative,
increase national saving and strengthen our
ability to compete successfully in the global
market place. Policy priorities therefore are
to prevent reacceleration of inflation,
maintain open markets to international trade and
investment, improve educational and health
standards, and reduce the federal deficit
while promoting domestic saving and
private capital formation.
MY REMARKS address some of the major economic policy issues that face the nation in the years ahead. Policy covers a lot of ground, both micro- and macroeconomic, so my approach is necessarily selective.
Government policies bear heavily on the specific issue of credit supply in the current economic expansion now under way. More broadly, policies we pursue will be crucial in addressing the issue of a potential shortage of global financial capital during the 1990s. Let me begin, then, with a review of this nation's growth trends and what the government projects out to the mid-1990s. Then we can examine the assumptions and reasoning behind the numbers, including policy requirements and what this Administration aims to achieve.
A LONG-RUN PERSPECTIVE
Real GNP growth in the U.S. has averaged 3.1 percent during this century -- a ninety-year span covering a wide variety of economic conditions. In the post-World War II period, growth averaged 3 1/4 percent. And during the most recent economic expansion, growth averaged a respectable 3 1/4 percent from late 1982 to mid-1990.
Against this background of our economic performance over extended periods, what can we reasonably expect in the years ahead? Projections by the federal government call for a modest and durable economic expansion, one that is consistent with progress in steadily reducing unemployment and keeping inflation subdued and on a gradually declining path. The base case forecast of the Administration has growth about 3 1/2 percent during 1992, slowing to a 3 percent path by 1995-96, and averaging a solid 3 1/4 percent over the five-year period.
UNDERLYING DETERMINANTS OF GROWTH
Now let's look at some of the factors underlying these numbers. At bottom, the determinants of a nation's long-run economic growth are demographics and productivity. Many factors in turn influence these critical growth determinants, including public policies. The key demographic elements, growth in population and labor force participation rates, are influenced partly by public policy. For example, immigration policy affects population growth, while tax policy and the social security earnings test affect participation rates. Productivity improvement depends primarily on capital formation, education and training, and technological change, which are particularly subject to the influence of policy. Both monetary and fiscal policies affect consumer decisions to spend or save and influence business decisions to invest in physical capital, R & D, to enter the export business, or to move production facilities off shore.
Two important demographic trends are embodied in the government's growth projections for the 1990s: a slowdown in population growth and a maturing of the workforce. The civilian labor force will increase at a slower pace in the years ahead, compared with growth during the late 1980s. The slowdown stems from lower growth in the working-age population and in the female participation rate. Because the gap between male and female participation rates has rapidly narrowed, we anticipate an attenuation of that process. Less growth in the labor force, however, should not constrain real GNP growth on a one-to-one basis because we expect offsetting developments. For one thing, as recovery unfolds, the margin of unemployed resources declines -- so that employment will increase faster than the labor force itself. More important is the expectation that labor productivity in the private sector will increase at nearly a 2 percent rate in the years ahead. As the composition of the labor force shifts towards workers who are more mature and have greater work experience, productivity will also benefit. Productivity in the nonfarm business sector increased at our projected rate of 2 percent during the first six years of the past expansion. We can do it again with an appropriate policy mix that fosters innovation and productivity-enhancing activities.
Sound monetary and fiscal policies are crucial to achieving our medium-term growth projections. As I have suggested, credible and systematic policy really can make a difference in an economy's growth path over time. So let me turn now to the role of government policy.
PRIORITIES OF ECONOMIC POLICY
We need to take a long-term approach to economic policies that reward private initiative, increase national saving, and strengthen our ability to compete successfully in the global marketplace. To these ends, I view our policy priorities as follows:
1. Prevent any reacceleration of inflation and aim
for a further reduction in inflation over time.
2. Maintain open markets to international trade
and investment, and continue our efforts to
reduce and eliminate impediments to trade.
3. Strive to improve educational and health
standards, both of which will enhance labor
4. Reduce the federal deficit by reducing
government expenditures as a percent of GNP
and promote domestic saving and private
capital formation while attending to the needs of
our nation's infrastructure.
Let me elaborate on each of these broad policy objectives.
I think it is abundantly clear that to maximize long-run economic growth, we must maintain an environment of relative price stability, so that economic decisions can be made on the basis of fundamental factors. Policymakers are keenly aware of the heavy price our nation paid to bring inflation in consumer prices down from the 12-13 percent range in 1979 and 1980 to about a 4 1/2 percent core rate in recent years. The Federal Reserve is determined not to allow a reacceleration of inflation, let alone a reoccurrence of double-digit inflation. This Administration wholeheartedly endorses the Fed's policy goal of aiming for a clear downward trend in inflation during the years ahead. At present, the core inflation rate is adjusting downward to the impact of slower monetary growth in recent years.
As a general matter, pursuit of sound monetary policies in other major industrial countries will have important implications for financing global economic expansion. For the most part, international capital markets are now well integrated. But capital mobility is not perfect for various reasons, such as exchange rate volatility and the associated risk of capital losses. Promotion of price stability among countries should reduce uncertainty about exchange rates and improve the mobility of financial capital among countries.
The federal government can help reinforce the Fed's anti-inflation policies by reducing structural impediments in product and labor markets, which can increase the transitional costs of adjusting to lower inflation. Indeed, we need to be alert to the entire range of policies, laws, and regulations that may exert an upward bias on prices and a downward bias on output. But we should also recognize that certain mandated increases in costs and reductions in measured output -- such as recent amendments to the Clean Air Act, for example -- reflect unmeasured benefits to society. We are attempting to incorporate those benefits into our system of national accounts, but that is a necessarily slow process. President Bush has proposed a number of economic reforms regarding farm subsidies, various entitlements, the health system, housing, education, and banking. If enacted, these reforms will have a positive influence on productivity.
ROLE OF INTERNATIONAL POLICY
International economic policies continue to have a high priority and will play a prominent role in our long-term growth prospects. I need hardly remind this audience that exports have been one of the major forces driving U.S. economic growth since the 1980s. From 1985 to the second quarter of 1991, U.S. exports of goods and services rose by a very impressive 78 percent in real terms; the rest of real GNP increased only 7 percent over that period. While it is unlikely that export growth of such magnitude can be sustained over the next five years or so, it is realistic to expect exports to increase much faster than the rest of GNP.
The policy role of the government is clear. As a general matter, the federal government's primary responsibility in the trade area, as in other areas, is to promote a healthy national economic environment by pursuing sound, credible, and systematic monetary and fiscal policies. On the micro side, we must emphasize a market orientation to enhance the flexibility of the economy to innovate and expand production. Our firms should be able to compete on even terms with other nations. To this end, we will continue our efforts to reduce unfair practices and trade-distorting measures in other countries. And we continue our efforts to gain a more level playing field in the European Community as the unification process moves forward.
Our long-run growth prospects depend partly on the extent to which other countries move toward market-oriented economic systems with open trade and investment policies. We will continue to encourage and support economic and political reforms in Eastern Europe and Latin America. President Bush has recognized the opportunities for expanding trade and investment in Mexico and South America. Our goal is to negotiate free-trade areas with individual countries or groups of countries, with eventual removal of all trade barriers. Price supports and trade barriers, as we know, distort profits and undermine incentives to attract capital to the most efficient industries and countries that offer the highest returns.
Finally, the Administration's proposed financial reform to modernize our banking system is a key element in our overall strategy to promote growth, increase market discipline and improve our international competitiveness.
INVESTMENT IN HUMAN CAPITAL
Educational and health standards of our people demand attention in the years ahead, which brings me to another policy priority of the 1990s. The Administration's budget includes initiatives to strengthen our educational system and to promote a healthier America. The primary responsibilities, however, lie with state and local governments and the private sector. We are relying heavily on the principles of increasing choice among users of social services, and on increasing competition among the providers of these services.
Carefully targeted outlays for health and education amount to investment in human capital, which has a large payoff in terms of productivity improvement. A healthier, better-educated labor force is crucial to our goal of raising productivity growth and maintaining a competitive edge in a rapidly changing world economy. Several points are worth noting here. First, higher labor productivity stemming from improved education and health implies higher levels of income and saving, even if the saving rate remains unchanged. Second, education is less mobile internationally than capital goods or financial capital; investment in human capital tends to remain in this country where we can reap the benefits. Skills of young entrants to the labor force today need improvement; our students regularly perform below the standards of their peers abroad on various tests of academic achievement. It is especially important to upgrade the skills of minorities, who will constitute an increasing share of the labor force during the nineties.
DEFICIT REDUCTION AND THE ROLE OF NATIONAL SAVING
The last major policy issue over the medium term -- perhaps the one with the highest priority -- is the need to reduce the federal deficit and increase national saving.
Achievement of our goals for real GNP growth during the 1990s depends importantly on progress in systematically reducing the federal deficit. For the time being, this fiscal year and next, the deficit will reach record levels in nominal terms because of the recession and outlays for deposit insurance. The long-run trend, however, is clearly favorable. Beginning in fiscal year 1993, we expect the federal deficit to be on a steady downward path as a result of the multiyear budget agreement reached last fall. Caps on certain spending categories and pay-as-you-go provisions in the budget process are now in place.
Growth in federal expenditures below the rate of inflation in the year ahead, including plans for downsizing the defense establishment, will help free up resources for private-sector activities. A cut in government spending as a general matter is preferable to an increase in taxes. Saving in the private sector tends to drop less when the federal deficit is reduced by cutting spending than when it is reduced by raising taxes. However, we must not neglect the growing needs for investment in the public infrastructure -- a substantial contributor to capital formation, productivity, and long-term economic growth. Indeed, the President's budget proposals call for increased federal investment in the nation's transportation facilities and in research and development.
The budget also includes initiatives to encourage private saving and investment. Proposals include a permanent extension of the research and experiment tax credit, incentives for private investment in economically distressed areas, family saving accounts, a capital-gain-tax differential, and penalty-free withdrawals from IRAs for first-time home buyers. The key point is that any policy measure that reduces the sum of private plus public consumption as a share of GNP will raise the nation's saving rate.
A higher national saving rate, if realized, will have a payoff in terms of a lower cost of capital to private investors in plant and equipment. It also means we will be able to finance more of our investment from domestic sources and relatively less from foreign capital. The U.S. generates internally most of the funds needed to finance its economic expansion; households account for the lion's share. Foreign lending in our credit markets, while important, is frequently exaggerated. During the eight-year period 1983 to 1990, households contributed on average about two-thirds of the total funds advanced to meet nonfinancial credit demands in the U.S. economy. The foreign sector's share of funds supplied ranged from as little as 6.9 percent (1983) to maximum of 15.4 percent (1987). The net inflow of foreign capital continued to supplement domestic saving in the early 1990s, but at a reduced rate as our trade deficit narrowed.
THE GLOBAL FINANCIAL ISSUE
An issue closely related to our goal of reducing the deficit and raising national saving involves the adequacy of global financial capital during the 1990s. I share the concern of many analysts over a potential shortage of financial capital for the world economy. Of course, no shortage can occur in an economic sense because interest rates and foreign exchange rates will tend to equilibrate the demand for capital with the international supply. Concern stems from the perceived increased capital needs for restructuring and developing the economies of eastern and central Europe, the Soviet Union and Latin America, and for rebuilding the infrastructure of war-damaged economies in the Middle East. Increased capital demands are expected to coincide with reduced saving flows from Japan, Germany, and the OPEC region. Competition for the world's supply of capital will increase as the U.S. recovery gains momentum and other countries in recession experience recovery.
The issue, then, is whether the supply of capital will increase as fast as demand. If not, global real interest rates will be higher than otherwise would be the case. Such an outcome would not necessarily be an adverse development. Much of the global investment in the years ahead, especially as it occurs outside the U.S., will reflect the replacement of obsolete capital with more efficient equipment, and the restoration of a badly damaged environment in some areas.
On an encouraging note, the IMF recently projected that the average national saving rate for industrial countries will rise by nearly 2 percent of GNP from 1991 to 1996. This follows a decline of about 4 1/2 percentage points from 1967-73 to the 1980s. The net use of saving by the public sector is projected to decline relative to GNP in countries where government deficits are high -- the U.S., Canada, Germany, Italy, and Japan.
Let me conclude my remarks on economic growth and policy issues for the 1990s with a few observations. The policy challenges I have discussed amount to a tall order. Fortunately, they are not mutually exclusive; action on one front will tend to reinforce progress in another area.
With a credible and systematic mix of macro and micro policies, we can achieve and sustain growth in the zone of 3 percent out to the beginning of the twenty-first century. At this rate national output and income double each generation. We should look forward to substantial improvement in our standard of living during this decade.
Michael R. Darby is Under Secretary for Economic Affairs and Administrator, Economics and Statistics Administration, U.S. Department of Commerce, Washington, DC.
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|Author:||Darby, Michael R.|
|Date:||Jan 1, 1992|
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