WHY IS THE U.S. SETTLING FOR STUNTED GROWTH?
Economic growth has fallen on hard times. The budget struggle between Congress and the Clinton Administration has been partly over whether the economy will grow 2.3% annually or 2.5%. Federal Reserve Board Chairman Alan Greenspan has hinted that even this slow growth might not be possible without a balanced budget.
It was not always so. In the postwar era, growth was a liberal mantra. Not even inflation-shy Republican Administrations could withstand its imperative. The Ford Administration, for example, forecast a growth rate of 5.98% in average annual real gross national product for the 1976-80 period. The Carter Administration brought us into the 1980s with a 4.7% average annual real GNP growth projection for 1979-83.
The attitude toward growth changed remarkably in 1981, when the Reagan Administration forecast a 3.8% annual rate of real GNP growth from 1981 to 1985. The forecast was paltry compared with those for earlier periods and was no higher than what the economy achieved from 1976 to 1980. But the hyperbole flew fast. Reagan's forecast was denounced as a "rosy scenario" that "lies far beyond the limits of any past experience in this country or any other industrial democracy" (The Washington Post, Mar. 9, 1981).
COOLED PASSION. What happened in such a short time span to make modest economic-growth projections unwelcome? Environmental hysteria connecting growth with pollution took a toll, as did the rising inflation that had accompanied growth in the 1970s. But among macroeconomists themselves, the cooled passion for growth may have reflected the change in the way it was being pursued.
In the postwar era, prosperity-peddling Keynesians connected economic growth with the growth of government. True, in the Keynesian model, a tax cut that increased the deficit would raise aggregate demand and economic growth, but the tax cut multiplier was less than the government-spending multiplier. That is, if economic growth was the goal, more government spending was the efficient way to achieve it. Keynesian economics was a political success because it merged economic growth with liberal compassion and the propensity of politicians to build spending constituencies. Moreover, the Keynesian model relied on a proactive government to manage aggregate demand and produce full employment. Policymakers found this to be a more gratifying approach than laissez-faire.
Reagan's growth program was unpopular with macroeconomists because it was not premised on the growth of government. Indeed, Reagan wanted to curtail the growth of government, while increasing economic incentives to individuals. This cut to the emotional core, and liberals who couldn't get enough "Keynesian" growth were horrified at the prospect of "supply-side" growth.
For many, supply-side economics has an even worse strike against it. It maintains that fiscal policy works not by increasing aggregate demand, but by raising aftertax rewards for work and investment. Supply-side economics not only tolerates market-based income differences--it also links tax policy with productivity growth and shows the high cost of using taxes to level incomes.
Liberal economists have responded not by resurrecting Keynesian demand management--an impossible task--but by deemphasizing growth. One way of doing this is to argue that regardless of policy, the economy cannot grow any faster than its long-term average of 2.5% annually. Liberals then narrowly limit economics to "fairness" issues. For example, Paul R. Krugman, an economist at Stanford University, says that with a long-term growth potential of 2.5%, it is pointless to increase incentives when the only effect is more economic inequality.
A downsizing of growth ambitions requires harsher cutbacks in welfare and entitlements in order to contain the deficit or balance the budget. It also means that policymakers cannot rely on income growth to compensate for the slower growth in government programs or on job growth to absorb the inflow of legal and illegal immigrants. The social and political implications of slow growth may well prove more unpalatable than "greed."
From 1982 to 1989, the U.S. economy grew at an average annual rate of 3.7%. The new "2.5% inevitable growth school" may argue either that these seven years of above-inevitable growth occurred at the expense of future growth or compensated for below-inevitable growth in the past. But the fact remains that people experienced 3.7%, not the long-run average. The electorate liked it, and the Washington policymakers who took it away are history.BY PAUL CRAIG ROBERTS