The Serious Policy Issues Facing the United States

Murray Weidenbaum

      Murray Weidenbaum is the Mallincrodt Distinguished University Professor at Washington University in St. Louis where he is also the honorary chairman of the Weidenbaum Center on the Economy, Government, and Public Policy. This is the text of an address given to the Westwood Country Club in St. Louis, MO, September 10, 2003.

      The presidential election campaign has started early. That is usually a bad time for any serious discussion of public policy. After all, I still remember one presidential campaign where the most important issue seemed to be the status of Quemoy and Matsu. Those were two trivial and virtually deserted little islands off the coast of Taiwan. There also was a presidential debate on closing the missile gap. After the campaign, it turned out that there was no U.S. missile gap. In fact, it was the Soviets who had the missile gap.

      On the economic front, we more recently witnessed a campaign successfully attacking the sitting president for not doing anything to get us out of recession. The data now show that the upturn in the economy started well before election day. Under current circumstances, I confidently forecast that Republicans will tell us how great this wonderful economy is, while Democrats will be crying in their beer because of the horrible economic conditions we are experiencing.

      Before we get caught in the campaign crossfire, let me try to sketch out what I believe to be the serious questions facing the American people. Who knows, we may yet be pleasantly surprised by a candidate dealing with some of these tough matters. In any event, these problems will be here after the polls close on that fateful Tuesday in November.

      To get us started, I would like to lay out the serious policy issues that will face the President of the United States, Republican or Democrat, who is inaugurated in January 2005. We can summarize that presidential policy agenda with eight key questions:

1. How can the United States achieve a stronger economy?

2. Related to that, how can we avoid inflation as well as deflation?

3. How can we reduce those huge budget deficits?

4. What do we do when the temporary tax cuts expire?

5. How can we finance Social Security and Medicare when the baby boomers retire?

6. How do we cope with rapidly expanding government regulation?

7. How can we meet the global competitive challenge, especially from China and India?

8. How do we face future threats to the national security?

      Even if I had the capability, I do not have the time tonight to even try to provide comprehensive answers to each of these questions. However, as an economist I believe that I can provide some helpful starting points.

A Stronger Economy

      As you may have noticed, the American economy is not exactly booming. Nevertheless, an upturn is now underway. The economy is rising by about 2 1/2 percent this year. Three rounds of tax cuts and quadruple that number of interest rate reductions have provided substantial stimulus to a sluggish economy. Declines in oil prices have helped lower the cost of domestic production and a drop in the international exchange rate of the dollar is encouraging exports. The continued upturn in military procurement is another plus to the economy.

      Nevertheless, my rubber band theory of business cycles seems to be working well—surely better than the more formal econometric models. Sharp and long recessions generate big snapbacks. Mild recessions, however, are usually followed by shallow recoveries. That happens because there is no opportunity for the accumulation of large backlogs of unmet business and consumer demands. Surely, this is our current experience. The result is a slow and drawn out recovery.

      At this point I suggest that we let the economic medicine do its work and not overdose the patient. Decision makers in Washington, D.C., always want to show the public how active they are. However, they now would be well advised to take an economic form of the physicians’ Hippocratic Oath: first pledge to do no harm.

      We had a good reminder of the need for a moderate economic policy during this summer. When the new higher budget deficit numbers were published, interest rates started to turn up. Additional federal spending programs, designed to prod the economy, could have further adverse economic effects—especially if they led to another round of interest rate increases.

      We do have to get used to the fact that we are now living in a very different economic environment than the 1990s. That was an unsustainable boom time. The economic future is likely to be more modest than the feverish pace of the last decade. I do not expect that the United States in the coming decade will see economic growth of well over 4 percent for three years in a row, as we did in the late 1990s. Fortunes will not be made as frequently, nor lost as quickly in this new and more sustainable economic environment.

      By the way, a lot of people are suspicious of any report that the economy is turning up, whatever the rate, so long as unemployment stays high. A little lesson in economics may be in order. We have a growing population—about 1 percent a year. With rising productivity, the average worker produces more, about 2 percent a year. That means that the economy has to grow by 3 percent just to keep unemployment steady. We only bring down the unemployment rate when the economy is growing faster than 3 percent. That is why earlier this year, while the economy was growing slowly, the unemployment rate was edging up.

      I console my students with the fact that, if the economy were not so complicated, we would not need so many economists.

Inflation and Deflation

      In recent years, the United States has avoided the economic extremes of inflation and deflation. Of course, some individual prices—especially of services—continue to rise even when the economy is weak. Meanwhile, the prices of other items, mainly manufactured goods, decline even when the economy is growing. Prices of individual products frequently fluctuate, especially in response to new technology or foreign competition. Those forces are always present in a healthy and dynamic economy. On balance, we have achieved an unusual degree of overall price stability. The peddlers of doom and gloom may generate some headlines. But, inevitably, they depart from the scene.

      Some members of the Federal Reserve Board have been making statements on inflation and deflation which are subject to varying interpretations. However noble their intentions, they often have confused financial markets. At this point, I believe that the Fed Board would be well advised to take a long vacation. The time for additional monetary stimulus is over. Over the past decades, the Fed has done a good job and they should leave well enough alone.

Tax Cuts

      As you may have noticed, Congress has added a new gimmick to the already complex Internal Revenue Code. To limit the reported size of the tax cuts, expiration dates are now set. Thus, in the case of the tax reductions voted earlier this year, the child credit and the marriage penalty relief run out in 2005. Small business expensing ends in 2006. Dividend rate reductions only extend to 2009. And the general rate cuts terminate in 2010. There are so many “sunrises” and “sunsets” in the new tax bill that the tax experts in Washington call it the Fiddler on the Roof Law.

      It is unlikely that Congress will let all of those tax benefits expire. That would be equivalent to a series of tax increases. However, extending the cuts will reduce the future flow of revenue to the Treasury—even after making a generous allowance for the feedback effect of faster economic growth. All that would make it more difficult to return to small deficits, much less to the budget surpluses we experienced in 1998-2001.

      Moreover, the goal of comprehensive tax reform—which is endorsed by almost every presidential candidate—is as illusive as ever. Nevertheless, the increased complexity of the tax system generated in the last few years makes true tax reform more necessary than ever.

Social Security and Medicare

      Now let us turn to the spending side of the budget. To put the problem in a nutshell, Congress has voted more benefits than revenues to pay for them. Some researchers have tried to quantify that imbalance for the years ahead. The results are staggering—totaling trillions of dollars of promised but unfinanced benefits. The big surprise, at least to me, is that, however large the Social Security deficit will be, the Medicare finance problem will be many times worse.

      Financing Social Security in the years ahead will be especially difficult because of the underlying demographic trends—and the odd way we are responding to them. Let me try to describe the basic policy problem. Despite all the scare talk about dangerous chemicals and other hazards in the environment, Americans are living longer. Over the past 30 years, average life expectancy has increased from 71 years to 77. At the same time, on average we are retiring earlier. The most common age of retirement has fallen from 65 to 62. Reducing the number of years that we pay into the Social Security trust fund and lengthening the period over which we receive benefits is a tough combination for those administering the Social Security program and other government retirement programs.

      On past occasions, I have suggested that Social Security benefits should start at age 65, not 62. I once had the temerity to propose that change at a meeting of a commission on financing retirement on which I was serving. Talk about getting hooted down. But I still believe it is a good idea. More fundamentally, Congress has to decide whether Social Security is a retirement system or a welfare program. Now it is a combination of both, even though we do not usually think about it that way.

      Yes, it sounds harsh, but granting every Social Security retiree an automatic annual cost-of-living (COLA) increase is the economic equivalent of welfare. The COLA is paid for by somebody else, by the working population. Surely, the typical private insurance policy does not have a COLA provision. When I made this point in public during my White House days, one congressman called for my impeachment. Fortunately, I worked for a president [President Reagan] who knew when laughter was the appropriate response.

      While I am voicing unpopular thoughts, let me say that the basic shortcoming of Medicare is an attitude encouraged by both political parties: “I want the best possible medical care, especially if somebody else is going to pay for it.” To start the necessary but difficult reform process, I would use an approach imbedded in the typical automobile insurance policy: institute a reasonable deductible so that we do not swamp the health care system with paperwork for small claims. In health care, insurance should not include routine visits to the doctor, but it should extend generously to cover major illnesses.

      Unfortunately, government is not good at making tough long-run decisions early. Unless big changes are made, Social Security and Medicare are likely to run out of money—but not in the next few years. There is an important lesson to be learned from the S&L bailout of the 1980s—the longer you wait to act, the more difficult and more expensive is the bailout. I guess members of Congress are not exactly quick learners.

Government Regulation

      Since 2001, we have seen the fastest increase in government regulation in a very long time. The number of federal regulators today is 47 percent higher than last year’s total. By far, the largest part of the increase—but not all of it—is in airline security. Like most Americans, I believe that preventing terrorist attacks is very important.

      Nevertheless, it was sad to see that, in setting up the new Transportation Security Agency, Congress did not apply the lessons from previous regulatory experiences. One of those unlearned lessons is that hastily written laws are most likely to contain serious defects. That is especially so in the case of statutes setting unrealistic deadlines.

      The unfortunate result has been unnecessary costs and needless disruption. Virtually every traveler has a horror story. I will not add to your collection—unless you press me. As in many other areas of regulation, the unanticipated consequences are severe. In this case, I believe that a major reason for the poor financial shape of the airlines is that many potential passengers have been scared off by the arbitrary and inconsistent application of those new inspection rules.

      The most fundamental shortcoming of the regulatory process—and recent regulatory legislation is no exception—is that each of these regulations is written in isolation, as if nothing else mattered. Just try asking whether there is a better way of achieving a given regulatory objective—whether there is a more cost/effective approach to clean water or healthier air or airline security. From my own experience in a variety of regulatory areas, I assure you that you will be lambasted for trying to undermine the regulatory objective. That close-minded attitude is equally apparent whether the subject is global warming or worker safety.

Global Competition

      Let us take up another political hot potato—global competition. It does not reduce my commitment to free and open markets at home and abroad to state that American companies are facing rising global competition. To clear the air, let me say that most of the charges that foreign producers are engaged in unfair dumping of their products in our markets turn out to be groundless. It is not unfair for a company with lower costs to charge less than their competitors. American firms do that whenever they have the opportunity. We also have post-Christmas clearance sales without violating any laws, but when foreign producers try to do that, the chances are they will run afoul of our punitive anti-dumping laws.

      We should worry about the real reasons why some domestic firms cannot meet the foreign competition. It is unfair for government programs and union rules to increase the cost of production in the United States. Featherbedding and needlessly burdensome regulations are luxuries that we have to dispense with if American companies are going to meet increasingly tough foreign competition.

      Perhaps the most curable competitiveness shortcoming is the inadequate education and training of millions of young Americans who are our potential workforce for the years ahead. We cannot blame the dropout rates in our central city high schools on foreign competition. It is sad to boast that the United States is number one among the industrialized nations measured by the high school dropout rate. By the way, we spend a lot more per student than other countries. The dropout problem is not the result of a lack of dollars for education.

      In terms of foreign competition, a fundamental change is occurring which we need to understand better. I am referring to the evolution of China as an industrial power and the rise of India as a major service center. These strategic developments are generating problems as well as opportunities for U.S. business firms, workers, and consumers.

      There is considerable historical precedent which gives us some insight into the longer-term implications. In the early l9th century, Europe dominated the world economy. That monopoly ended with the rise of the United States as a major industrial power. Europe’s share of world commerce declined and the adjustments at times were painful. However, the overall results were very positive. Total world trade rose. So did living standards in both Europe and America.

      A similar situation has been developing in Asia. Japan became a major economic power in the 20th century—and the pace of economic development accelerated, with results comparable to the European experience in the previous century. In the 21st century, we can expect China and India to become world economic leaders. The effects —good and bad—are likely to be similar to earlier experiences.

      A word of warning arises from China’s earlier history. In the 15th century, China was arguably the most prosperous and advanced nation in the world. China was not the backward place that many Americans visualize. Rather, it was the innovator that Western nations followed. China invented paper, gunpowder, the cannon, the magnetic compass, the clock, the wheelbarrow, movable type, and nautical innovations such as the rear rudder. Chinese technicians were casting molten iron many centuries before Europeans discovered the process.

      What changed the situation? Suddenly, the Emperor of China arbitrarily cut off commerce with the rest of the globe. China descended into a long period of economic and intellectual stagnation, from which it has only begun to emerge.

      Nevertheless, there is a very positive side to the subject of international competition. The puppet-parading protesters so visible in Seattle and Genoa were wrong. The emotional outcries against the international economy were mistaken. Globalization is working. When we penetrate the noise, it turns out that those “terrible” multinational enterprises are creating widespread wealth. More people have moved out of poverty in the developing countries in the last two decades than ever before in world history.

National Security

      It is clear that we live in a dangerous world and that a substantial military force will be required for the foreseeable future. We can argue about the exact size and composition of the military establishment and, of course, when to exert that military power. Nevertheless, in view of the continuing supersized budget deficits, we know that there will be constant pressure from the proponents of civilian programs to limit the growth of military spending.

      Under the circumstances, it will be highly desirable to cut back the expensive but low priority vestiges of the Cold War that are still imbedded in the Defense Department’s budget. The place to start is to close down the military bases that are no longer needed in view of today’s security needs. There is no shortage of such potential candidates for the budgetary axe. Experience, however, tells us that every community affected will rise up in opposition. A solid phalanx of business, labor, and civic leaders will declare how essential this old military facility is for the region’s economic welfare and, of course, for the nation’s security.

      My favorite example is a base in the Washington, D.C., area which, by every standard, should be closed down. What keeps it going? By sheer coincidence it has a great golf course used by the top brass, military and civilian. Even more important than the base closings is the need to modernize the bureaucratic way in which the Department of Defense awards tens of billions of dollars of contracts each year.

      Military procurement dollars would go much further if the Pentagon would strip out the many bureaucratic restrictions that currently burden the acquisition of weapon systems. Examples include prohibiting the purchase of clothing and even fibers of “foreign origin,” mandating the procurement of items composed of the highest percentage of recycled material, and providing a monetary preference to low-noise emissions products. My favorite is requiring the purchase of specific supplies from the Federal Prison Industries. That appeals to my sense of irony because it is illegal to import any items produced by foreign prison labor.

      Surely, whatever presidential administration is in office in the years ahead will have to make many tough decisions in order to match military requirements and fiscal reality.

Conclusion

      As you can see, there will be no shortage of problems facing the United States in the years ahead. The sensible approach—which is not always followed—is to deal with these issues promptly, before they reach crisis proportions. It is also important to put these matters in perspective.

      Warts and all, the United States is still the freest society and has the strongest economy of any industrial nation on the face of the globe. That is not just the result of good luck. Our country possesses six special characteristics that are the key to our continued economic prosperity. Too often we take these factors for granted—and we should not:

      1. A strong entrepreneurial spirit. Americans are constantly starting up new enterprises. In contrast, most Europeans with discretionary resources are satisfied with just maintaining the status quo. One obvious manifestation is that they traditionally take much longer vacations—and simultaneously resent our greater economic success. More fundamentally, European businesses face far more onerous regulation than our companies—not that regulatory burdens are exactly light in the United States.

      2. A substantial small cap stock market. In no other country can a new business with a promising product idea hope to raise substantial amounts of capital in the equity market. Elsewhere, a new business typically has to rely on bank loans and family wealth.

      3. Comparatively low taxes. We all love to gripe about the high taxes we pay. I readily admit that I am no exception. However, in comparison with most other nations, we have a smaller public sector and therefore lower tax burdens.

      4. High labor mobility. Yes, it is easier to lay off workers in the United States than in Europe. But there is another side to the coin: American employers are far more likely to hire new workers. The overall result of these divergent trends, over the decades, is striking: job stagnation and high unemployment in Western Europe and job growth and lower unemployment here.

      5. World class higher education. Where do people in other countries send their youngsters to college, especially for advanced degrees? Not to Beijing University or Tokyo or Berlin, and certainly not to Riyadh University. Parents who can afford to do so send their young people to American universities. The research being performed at our major universities is also a vital asset, which leads to the last point.

      6. Advancing technology. A silent but strategic crossover occurred in the 1980s. Until then, most research and development (R&D) in the United States was sponsored and financed by the Department of Defense. Military needs determined the direction of the bulk of our scientific and engineering efforts.

      Since then, however, R&D has been primarily financed and sponsored by private enterprise. The business share is now up to 70 percent. That is a tribute to the power of private economic incentives. This massive civilian investment in the fruits of science and technology—tens of billions of dollars a year—can be expected to enhance American competitiveness. That will come about by generating a future flow of new and better commercial products as well as improved production methods. One result is already measurable. The United States consistently runs a surplus of exports over imports in high-tech products and services. Our strength in technology will be especially vital in the years ahead as China and India become more powerful competitors in the global marketplace.

      To sum up briefly, the United States will face a host of challenging public policy problems in the years ahead—and we will have tremendous resources to deal with them. Whoever is president in the years ahead, we can wish him or her good judgment and especially good luck. Let me leave you with the forecast of my favorite economist, the cowboy humorist Will Rogers. He said, “Things will get better, despite our efforts to improve them.”     Ω

“Energy in the executive is a leading character in the definition of good government. It is essential to the protection of the community against foreign attacks; it is not less essential to the steady administration of the laws; to the protection of property against those irregular and high-handed combinations which sometimes interrupt the ordinary course of justice; to the security of liberty against the enterprises and assaults of ambition, of faction, and of anarchy.” —Alexander Hamilton