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About this time three years ago, I wrote a radio commentary called "Growth Is Good." The commentary ended up sparking a lot of spirited criticism from listeners, ranging from my underestimating how growth would lead to inflation to my overestimation of the economic benefits from growth. The message to me: Fast economic growth was bad, bad, bad. And that idea lingers on today.
Back then -- in 1997 -- the economy had expanded at a 4% annual pace, and the unemployment rate had slipped below 5%. Investors feared that inflation was about to spiral higher. Many policymakers and mainstream economists shared a strongly held belief that the economy couldn't grow faster than 2%-plus, and unemployment couldn't drop below 6% without inflation rearing up.
I argued that the Fed should ignore calls to hike short-term rates. "Higher productivity, increased employment, and intense business competition are powerful forces for bringing inflation lower in a fast-growing economy. More people working and producing more goods and services does not reduce the purchasing power of money. Let the good times roll."
STIRRINGS STILL.
Pretty smart analysis, if I do say so myself. As we now know, the economy continued to grow at a 4% pace, the unemployment rate dropped to some 4% -- and inflation trended lower, not higher. Meanwhile, the Fed stayed on the sidelines.
Now, we're going through another inflation scare. Economic growth is robust, and there are some signs that inflation may be stirring anew. Specifically, the employment cost index is up 4.3% from a year ago, its worst showing in nine years.
But here I go again. I still think inflation is subdued and the economy should be given free rein. For instance, compensation per hour, which includes stock-option gains, is not accelerating, according to Merrill Lynch. Spending on high-tech gear surged at a 35% rate in the first quarter, much of it on the Internet, which may turn out to be the most powerful force ever for driving costs lower.
RISING TIDE.
Nevertheless, there's no doubt this time around that the Fed will hike interest rates to slow the economy. The only question is whether the central bank will raise the fed-funds rate, the short term interest rate it controls, by a quarter-point or by a more dramatic half-point.
What troubles me most is that the idea remains among investors, antiglobalism protesters, and Federal Reserve Board Chairman Alan Greenspan that too much economic growth is bad. Over the past quarter century, the idea took deep root that not only couldn't the economy grow very fast but that strong economic growth wasn't all it was cracked up to be. Besides, robust growth unleashed inflation.
Fast growth didn't raise the incomes of society's least advantaged, critics said. It encouraged people to spend beyond their means. And persistent poverty in much of the developing world also led many academics and policymakers to question the efficacy of economic growth as a means of reducing poverty. The title of economist Paul Krugman's 1989 book, The Age of Diminished Expectations, eloquently captured the reigning attitude toward growth.
Yet the social and economic story today is that a rising tide is lifting all boats. With the unemployment rate at a three-decade low, the wages of low-income workers are rising rapidly. Income inequality stopped widening about three years ago, and a record two-thirds of all households own their own home. From 1994 to June, 1999, the welfare caseload fell by 50%, or about 2.5 million cases, according to Gary Burtless, economist at the Brookings Institution. Over the same time period, unpublished figures from the Bureau of Labor Statistics show that the number of separated, divorced, and never-married mothers who hold jobs increased by more than 1.2 million.
TRIPLE GOOD.
Similarly, recent economic studies suggest that fast economic growth and lower poverty rates do go hand in hand in the developing world. An analysis of 26 developing countries by economists Michael Roemer and Mary Kay Gugerty of the Harvard Institute for International Development found that an increase in the rate of per-capita gross domestic product growth translates into a one-for-one increase in the average income of the poorest 40%. That means a GDP growth rate of 10% is associated with income growth of 10% for the poorest 40%. The relationship is marginally weaker with the poorest 20%. There, a growth rate of 10% translates into an income growth rate of 9.21%. However, a country's income distribution is much less sensitive to an economy's growth rate.
The U.S. economy is more productive and more competitive than at any point in the last century. The prospects for the world economy are also heartening. The worry shouldn't be that growth at home and abroad is too robust, but that economic pessimists will restrain the sense of optimism, of possibility, and the desire to take risks that drives economies forward. Growth is good, good, good.
Farrell is contributing economics editor for Business Week. His Sound Money radio commentaries are broadcast on Saturdays in 171 markets nationwide EDITED BY DOUGLAS HARBRECHT
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