Can Anyone Steer This Economy?

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What Stimulates Growth?

But enough of cataclysmic scenarios that might or might not happen. The question to ask is this: How does globalization affect the long-term policies for growth, both liberal and conservative, rolled out by the U.S. in recent decades? Probably the best known is supply-side economics, which originated in the 1970s and achieved prominence under President Ronald Reagan in the 1980s. Like all Big Ideas, the logic behind supply-side economics is clear: Lower tax rates give workers an incentive to put in more hours, encourage savings and investment by increasing the aftertax rate of return, and spur entrepreneurs to expand their businesses by allowing them to keep more of the profits.

According to Kevin A. Hassett, director of economic policy studies at the American Enterprise Institute, globalization actually increases the pressure to cut taxes. If tax rates are too high, "corporate income is so mobile that the money just leaves," says Hassett. "There's an international tax competition, and everyone is playing."

Yet economists are hard-pressed to find evidence that tax cuts have a big effect on growth. Last summer, the Treasury Dept. released a study that looked at the long-term impact of extending President Bush's tax cuts, which are due to expire at the end of 2010. The study concluded that extending the tax cuts indefinitely would boost GDP by only 0.7% over the long run. That's less than a rounding error.

It's also clear that having a low tax rate is only one factor among many determining international competitiveness. It's equally important to have an honest government, or an efficient health-care system, or an educated workforce. "There isn't a single blueprint for a successful economy," says Robert E. Hall, a Stanford University economist who was one of the main advocates of a flat tax in the 1980s.

Deficit Reduction

On to the next Big Idea: deficit reduction, a mirror image of supply-side economics that the Democrats have made the centerpiece of their political and economic agenda. "Fiscal responsibility is important for the long term," says Bruce Reed, president of the Democratic Leadership Council. "The overall economy is going to pay a price if the country is going broke."

The case for deficit reduction as a long-term growth strategy is also straightforward. Smaller budget deficits are supposed to boost national savings, which leads to lower interest rates, smaller trade deficits, increased investment by businesses, and more job creation. And certainly that's the way it worked in the 1990s, when Rubin was running economic policy under President Clinton—hence the name Rubinomics.

But this line of reasoning doesn't hold up so well in an economy that is far more exposed to global forces than it was in 1993, when Clinton took office. The financial markets have become far more seamlessly global, making the U.S. budget deficit a much smaller influence on interest rates. Today's roughly $250 billion deficit would use up about 14% of U.S. national savings. That's a big deal, but it's only 2% of global savings.

The ease with which capital flows across national borders helps justify the Bush Administration's relative lack of concern about budget deficits or even personal savings. "What starts to break down is the simple link between encouraging savings and encouraging investment," says James S. Poterba, a Massachusetts Institute of Technology economist appointed by Bush to his tax reform commission in 2005. "If Joe in Pittsburgh saves, we can't say that we benefit this factory in Harrisburg. The jobs we generate might be jobs somewhere else"—like overseas.