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^ THE 1993 ECONOMIC REPORT
OE THE PRESIDENT
"^ A /^q3/PT. I "^™^*
BEIORETHE
JOINT ECONOMIC COMMITTEE
CONGRESS Of THE UNITED STATES
ONE HUNDRED THIRD CONGRESS
EIRST SESSION
PARTI
January 27 and February 11, 1993
Printed for the use of the Joint Economic Committee
«iironcrnnov
JUN 2 ^ 199A
'^2®' U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON: 1994
For sale by the U.S. Government Printing Office
Suf)erintendent of Documents. Congressional Sales Office, Washington. DC 20402
ISBN 0-16-044030-0
\ I \ ^ .V. Hrc. 103-279
^ THE 1993 ECONOMIC REPORT
OE THE PRESIDENT
^ A /^q3/pr. I ^^^^^
BirORE THE
JOINT ECONOMIC COMMITTEE
CONGRESS Of THE UNITED STATES
OIME HUNDRED THIRD CONGRESS
FIRST SESSION
PART 1
January 27 and February 11, 1993
Printed for the use of the Joint Economic Committee
JUN 2 * 199A
'^2®' U.S. GOVERlMMtNT PRINTING OfHCE
WASHINGTON: 1994
For sale by the U.S. Government Printing Office
Superintendent of Documents. Congressional Sales Office, Washington, DC 20402
ISBN 0-16-044030-0
JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. S(a) of Public Law 304, 79th Congress]
HOUSE OF REPRESENTATIVIS
DAVID R. OBEY, Wisconsin,
Chairman
LEE H. HAMILTON, Indiana
FORTNEY PETE STARK, California
KNX^ISI MFUME, Maryland
RON NJTYDEN, Oregon
MICHAEL A. ANDREWS, Texas
RICHARD K. ARMEY, Texas
JIM SAXTON, New Jersey
CHRISTOPHER COX California
JIM RAMSTAD, Minnesota
SENATE
PAUL S. SARBANES, Maryland,
Vice Chairman
EDWARD M. KENNEDY, Massachusetts
JEFF BINGAMAN, New Mexico
CHARLES S. ROBB, Virginia
BYRON L. DORGAN, North Dakota
BARBARA BOXER, California
WILLIAM V. ROTH, JR., Delaware
CONNIE MACK, Florida
LARRY E. CRAIG, Idaho
ROBERT F. BENNETT, Utah
RICHARD McGAHEY, Executive Director
RICHARD F KAUFMAN, General Counsel
LAWRENCE A. HUNTER Minority Staff Director
(u)
i~>
llGLif .;
CONTENTS
WITNESSES AND STATEMENTS
EOR THE RECORD
Wednesday, January 27, 1993
PAGE
Obey, Hon. David R., Chairman, Joint Economic Committee:
Opening statement 1
Armey, Hon. Richard K., Member, Joint Economic Committee:
Opening statement 3
Sarbanes, Hon. Paul S., Vice Chairman, Joint Economic Commit-
tee: Opening statement 4
Saxton, Hon. Jim, Member, Joint Economic Committee: Opening
statement 6
Bennett, Hon. Robert P., Member, Joint Economic Committee:
Opening statement 8
Greenspan, Hon. Alan, Chairman, Board of Governors, Federal
Reserve System 8
Craig, Hon. Larry E., Member, Joint Economic Committee: Open-
ing statement 31
Andrews, Hon. Michael A., Member, Joint Economic Committee:
Opening statement 33
Dorgan, Hon. Bryan L., Member, Joint Economic Committee:
Opening statement 34
SUBMISSIONS FOR THE RECORD
Representative Armey: Written opening statement 49
Senator Sarbanes: Written opening statement 50
Mr. Greenspan: Prepared statement 52
Attachment: Letter to Senator Sasser 56
Senator Craig: Written opening statement 58
Thursday, February 11, 1993
10:00 a.m.
Obey, Hon. David R., Chairman, Joint Economic Committee:
Opening statement 59
Chart entited "Budget Deficits" 60
Chart entided "Federal Debt as a Share of GDP" 61
Chart entided "Debt of Private Nonfinancial Sector" .... 52
(iii)
IV
Thursday, February 11, 1993 (Continued)
10:00 a.m.
PAGE
Chart entitled "Shrinking Federal Investment" 53
Chart entitled "Real Net Nonresidential Investment" .... 53
Chart entitled "Nondefense Research and Development" . 54
Chart entitled "Economic Growth by Presidential Term" . . 55
Chart entitled "Employment Growth" 55
Chart entitled "Nonfarm Payroll Employment" 67
Chart entitled "Real Average Hourly Compensation" 68
Chart entitled "Real Average Hourly Earnings" 69
Chart entitled "Change in Share of Aggregate Household
Income by Quintile" 69
Tobin, James, Professor of Ecnomics, Department of Economics,
Yale University; and Nobel Laureate in Economics 70
Solow, Robert, Professor of Economics, Department of Economics,
Massachusetts Institute of Technology; and Nobel Laureate in
Economics 74
Meltzer, Allan, Professor of Political Economy and Public Policy,
Carnegie Mellon University 77
SUBMISSIONS FOR THE RECORD
Mr. Tobin: Prepared statement 102
Mr. Solow: Prepared statement 1 10
Mr. Meltzer: Prepared statement 113
Thursday, February 11, 1993
1:00 p.m.
Obey, Hon. David R., Chairman, Joint Econoimc Committee:
Opening statement 119
Chart entided "Debt Held by the Public" 120
Chart entitled "Real Hourly Compensation" 120
Chart entided "Real Average Hourly Earnings" 121
Chart entitled "Change in Share of Income" 122
Chart entitled "Real Net Investment" 123
Chart entitled "Nondefense Research & Development" ... 123
Chart entitled "Shrinking Federal Investment" 124
Sarbanes, Hon. Paul S., Vice Chairman, Joint Economic Commit-
tee: Opening statement 125
Wyden, Ron, Member, Joint Economic Committee: Opening state-
ment 126
V
Thursday, February 11, 1993 (Continued)
1:00 p.m.
PAGE
Marshall, Ray, Professor, University of Texas, LBJ School of Public
Affairs; and former Secretary of Labor 126
Weill, James D., General Counsel, Children's Defense Fund .... 132
Shapiro, Isaac, Executive Director, Center for Budget and Policy
Priorities I45
Vedder, Richard, Professor of Economics, Ohio University 14g
SUBMISSIONS rOR THE RECORD
Mr. MarshaU: Prepared statement 160
Report entided "A Human Resources Development Plan for
the United States" I54
Mr. Weill: Prepared statement I75
Mr. Shapiro: Prepared statement 183
Mr. Vedder: Prepared statement 191
THE 1993 ECONOMIC REPORT OF THE PRESIDENT:
ECONOMIC OUTLOOK FOR 1 993
Wednesday, January 27, 1993
Congress of the United States,
Joint Economic Committee,
Washington, DC.
The Committee met, pursuant to notice, at 10:00 a.m., in room 2237, Ray-
bum House Office Building, Honorable David R. Obey (Chairman of the
Committee) presiding.
Present: Representatives Obey, Andrews, Armey, Saxton, Fish and Roth;
and Senators Bingaman, Dorgan, Robb, Bennett and Craig.
Also present: Stephen A. Quick, executive director; William Buechner,
Lee Price, Glen Rosselli, Donald Tobin and Christopher Frenze, professional
staff members.
OPENING STATEMENT OF REPRESENTATIVE OBEY,
CHAIRMAN
Representative Obey. If I could ask everyone to take their seats, please.
Let me simply say that the Committee is in the process of being organized
for this coming Congress, and our new members are slowly but surely being
appointed to the Committee. I should announce that I have just been told that
Mr. Michel, the Republican Leader, has reappointed Mr. Armey from Texas
and has appointed Mr. Saxton from New Jersey to the Committee, with two
other appointments to be coming shortly. Frankly, I am not certain yet who
the Speaker has appointed on the Democratic side of the House. Ajid I as-
sume our Senate colleagues will be joining us shortly.
On behalf of the Joint Economic Committee, I am pleased to welcome our
distinguished witness this morning, the Chairman of the Board of Governors
of the Federal Reserve System, Alan Greenspan.
The Committee is here this morning to examine the economic outlook for
1993, and in particular how the Federal Reserve can contribute to strengthen-
ing the economic growth in 1993 and beyond.
This country has just come through three nightmare years of recession,
bare-bones growth, disappearing jobs and falling income. During the reces-
sion, which began in 1990, we lost more than 2 million payroll jobs and al-
most 10 million people were unemployed. Since March of 1991, in technical
terms, we have been in what economists technically call a recovery. But dur-
ing the past six quarters, the economy has grown at an average rate of 1 .9 per-
cent, less than one third the rate of average postwar recoveries.
That has not been enough to create jobs or put people back to work. We
still have 9.3 million people unemployed. There are more people unemployed
today after 21 months of recovery than there were at the worst point of every
other postwar recession but one.
In the private sector, which this country depends on very largely for its eco-
nomic strength, there are 1 .4 million fewer federal payroll jobs than there
(1)
were at the start of the recession. That situation at the current trends will per-
sist at least two more years.
That is probably why only 34 percent of Americans feel that the United
States is in a recovery, with 35 percent believing we are still in a recession
and 27 percent believing that we are in a depression. They define the econ-
omy in terms of what is happening in their own lives, based upon what they
see in their own real life experiences.
At the same time, on the other side of the ledger, the inflation situation now
is in better shape than at any time during the past 25 years — the inflation rate
was roughly 3 percent — except for 1986 when inflation was helped by a big
drop in oil prices. You have to go back to 1965 to find a lower inflation rate
than we had last year.
It is apparent that this country needs stronger job and economic growth.
This Committee held a hearing on December 30 under then-Chairman Sena-
tor Sarbanes, at which point Professor Paul Samuelson at MTF, a Nobel Lau-
reate in economics, and Professor Paul McCracken, who served on the
President's Council of Economic Advisers under President Nbcon, both testi-
fied that we needed roughly 4 percent growth in 1993, twice the growth we
have gotten so far in this anemic recovery.
The New York Times, which is not necessarily an economic source, but
nonetheless observed recently that we need 3.5 percent growth just to keep
the unemployment rate from rising. And they said this:
For three decades economists held to the rule that an annual growth rate
of two-and-a-half to 3 percent for the American economy was sufficient
to absorb nearly everyone seeking jobs and thus keep the unemployment
rate steady. But now with companies shrinking stafife and reorganizing to
become more competitive, economists think it will require more growth,
pertiaps more than 3.5 percent on average over the next two or three
years, to maintain the same equilibrium. We need 3.5 percent growth just
to tread water, and yet it has been almost four years since we have seen a
quarter of growth that strong.
Our need for stronger growth is demonstrated, I would suggest, also by the
fact that there is a very large number of firms which are expecting to reduce
their work force in the coming year. The announcement by Sears of their
plans to eliminate some 50,000 jobs is only the most recent example.
I think one of the most startling aspects of this problem is the fact that
while the country is used to seeing weak firms lose significant numbers of
jobs during recessionary periods, tihe country is not used to seeing massive
job loss on the part of the crown jewels, or at least what we used to think of as
being the crown jewels of the economy — corporations from IBM to General
Motors to Sears to you name it. When I was growing up, those were house-
hold words. Those were the dynamos of the economy.
We are starting a new year with a new president, with a lot of new mem-
bers of Congress from both political parties. That new president is committed
to stronger growth. I think it is fair to say that we hope the Federal Reserve
will have a very cooperative relationship with that new president.
Newspaper stories like the January 18 stoiy in the Times, with the title
"Clinton goes head-to-head with the Fed," if they are accurate are not very en-
couraging.
I was pleased to learn on Meet the Press this weekend, Mr. Greenspan, that
you and Secretary of the Treasury Bentsen have met twice, so far, and plan to
have weekly breakfast meetings. He hope those meetings do lead to close co-
operation between the Administration and the Fed, and help lead to a reversal
of the anemic performance we have had during the last three years.
The Committee is very pleased to have the Chairman of the Federal Re-
serve here with us today to discuss these issues. After I have asked Congress-
man Armey for whatever statement he would like to make, I will ask you to
proceed.
OPENING STATEMENT OF REPRESENTATIVE ARMEY
Representative Armey. Thank you, Mr. Chairman.
Let me say, it is a great pleasure, Mr. Greenspan, to welcome you here this
morning. I am going to have to retire early from this meeting in order to chair
a Republican conference. So please understand that I only leave reluctantly to
attend to other duties.
I am also here to note that no House members have been appointed to the
Joint Economic Committee, nor has any organizational meeting of the com-
mittee yet occurred. In other words, the JEC has no House members. It is sim-
ply inappropriate for the Committee to be conducting business. This is yet
another example of how much respect the Democrats pay to the rules of the
House. We should wait for our House members to be named before holding
hearings. As Jefferson argued, you must sit to sit.
This aside, I hope you would address the issue of Federal Reserve account-
ability this morning. Chairman Greenspan. The relationship of the Federal
Reserve to the Congress has been the subject of much discussion and legisla-
tion in the last few years.
A number of bills have been introduced that have the effect of, if not the
intent of, increasing congressional influence over Federal Reserve policymak-
ing. The record suggests this would be a great mistake.
I believe we saw President Johnson and William Martin go through this
circus at another time, and Martin was right and stood his ground.
Whatever may be said about the imperfections in Fed policy, there is every
reason to believe that congressional meddling would only make the situation
worse. After all. Congress has established a track record in exerting influence
in the financial sector, and we know this influence was often exerted in im-
proper ways.
Congress helped to create the half a trillion dollar S&L disaster that we are
still cleaning up after. We should finish cleaning up this damage before lead-
ing the charge on the debacle of the financial services industry.
The task of implementing federal policy is going to be left to the Federal
Reserve in coming years. Mr. Clinton, after falsely condemning the Republi-
cans for raising taxes on the middle class, now is proposing to do exactly that,
despite his promises to cut your taxes. Nevertheless, during the campaign,
when Mr. Clinton stated his view that the Federal Reserve policy had been
about right, in light of his statement, why all the recent Democrat Fed bash-
ing? It would appear Democrats have so little confidence in their ever chang-
ing federal policy that this Administration needs a scapegoat once again.
A convenient whipping boy will be required. Chairman Greenspan, I don't
envy you your new role in our government. And let me say personally, I have
long since been arguing that there is too much tendency for fiscal policymak-
ers to fail in their duty and then call on the Fed to do even more super heroic
things to get the fat out of the fire that has been put in by fiscal policy care-
lessness. And I think the Fed is scapegoated far too much.
I fear, Mr. Chairman, that somebody is preparing a whipping post in your
honor. I want you to know that I believe you will get far more blame than you
deserve in the coming months. I will try at least to speak on behalf of a bal-
anced, responsible fiscal and monetary policy. And I am very confident that
the letdown is on the fiscal end.
Thank you, Mr, Chairman.
[The written opening statement of Representative Armey is on p. 49 of the
Submissions:]
Representative Obey. I thank the gentlemen for his balanced and responsi-
ble statement.
Mr. Greenspan, I have been told that several other members have opening
statements they would like to make. So I will ask your forbearance and ask
them to proceed first.
Senator Sarbanes, please proceed.
OPENING STATEMENT OF SENATOR SARBANES, VICE CHAIRMAN
Senator Sarbanes. Thank you very much, Mr. Chairman.
I am very pleased to join with Congressman Obey in this hearing with the
Chairman of the Board of Governors of the Federal Reserve, Alan
Greenspan.
Mr. Chairman, last year was not a good year for American workers and
their families. It started with unemployment at 7.1 percent, it ended with un-
employment at 7.3 percent, and unemployment stayed above the 7 percent
figure all year.
The average number of people unemployed each month was 9.4 million,
which means that some 23 million people or more were jobless at least once
sometime during the year.
In addition, there were more than a million people who were so discour-
aged by the lack of jobs that they simply gave up looking, plus over six mil-
lion who worked at part-time jobs because they could not find full-time jobs.
They wanted flill-time, but they could only fmd part-time jobs.
According to the National Bureau of Economic Research, the economy has
been in a technical recovery since March 1991. The GDP is rising, but only
one third the rate of previous recoveries, and that is too slow to create jobs.
The unemployment rate for December, in fact, was five-tenths of 1 ppr-
centage point higher, higher than the unemployment rate at the recession
trough in March of 1 99 1 .
While technically this may be a recovery, it is still very clear that we are in
a jobs recession. Arid the movement on the economy in this recovery period
is in marked contrast with previous recoveries.
I just want to just draw this contrast. This is the growth of payroll employ-
ment from the trough. Here is the trough. The green line here is the recovery.
recession recovery cycle in the seven previous post- World War II recession
recoveries. What we did, we went down in the trough and came out. We re-
covered all the jobs that had been lost and even more by this time in the re-
covery cycle. This time we are way down here. We have recovered about 20
percent of the jobs that have been lost. (See chart below.)
The Jobs Recession
Growth of Payroll Employment from Trough
3
O
E
o
0)
w
(0
0)
u
c
u
0)
Q.
7.0%
^
y
6.0%
7 Previous •
Recession-Recovery ^
5.0%
Cycles* ^
•
4.0%
•
•
3.0%
y
2.0%
/
•
•
^•^^^^ N
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^■*>>. \
•
1.0%
^Vi. s
/ Current Recession-
^s^
y Recovery Cycle
0.0%
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^ ^ _,-„ ,- ~
* Eiclud** 1980 Mlnl-R«c««slon
1 .0%
■ • ■ , ■ ■ ■ 1 I I ! I ; 1
-6 -3 Trough +3 +6 +9 +12 +15 +18 +21
Months from Trough
Sourcft: Bureau of Labor Statlatlca and Joint Economic Commiltea
This is a very marked discrepancy between what is going on this tirne and
what has gone on previously. In my judgment, the principal economic task
facing the country now is to achieve a rate of growth fast enough to make real
and substantial progress on the jobs front. To achieve this, we will need eco-
nomic policies which focus on strengthening the pace of recovery,
I have been very concerned recently that monetary policy may not be ade-
quately supportive of recovery in the labor market. At the last meeting of the
Federal Open Market Committee, the members of that committee indicated
considerable support for a lower target for money supply growth in 1993.
And I am now quoting from the minutes:
During the discussion, the members generally agreed that developments
since mid- 1992 had reinforced the case for some reduction in the 1993
range for M-2, and they indicated that they probably would support pro-
posals for a lower range.
lowering the target for money growth implies that the Fed is content with
the anemic rate of growth that we have had so far in this recovery.
I find it incredible that the Fed would consider lowering its targets for
monetary growth in light of the growing consensus among economists that
slow growdi of the money supply over the past several years has been a sig-
nificant factor producing tiie current jobs recession.
In fact, for most of this year, money growth has failed to reach even the
lower target range as set by the Fed. Since the trough of the recession, the real
money supply has actually fallen in contrast to past recoveries when the Fed
aggressively expanded the real money supply by a range of anywhere ft-om 6
to 16 percent, thereby fostering much stronger economic growth.
Experts from both sides of the political spectrum across the range agree
that money growth has been too slow, and monetary policy too tight, for
much of the recent past.
On December 30, this Committee held a hearing on the conduct of mone-
tary policy, and heard similar testimony from two of the nation's foremost
economists. Professor Paul Samuelson of MIT, our first Nobel Prize Laureate
in economics, told the committee, and I quote him:
Monetary policy in 1992 missed an important opportunity to lean against
the wind of a continuing American growth-recession. Economic history
textbooks of the future will attribute George Bush's defeat and William
Clinton's victory to Federal Reserve actions which from mid- 1990 to
mid- 1992 were repeatedly too little and too late.
Professor Paul McCracken of the University of Michigan, a former Chair-
man of the President's Council of Economic Advisers, testified, and I quote:
The management of U.S. monetary policy thus far in the 1990s will not
go into the annals of central banking as a distinguished performance. It
has been inappropriate for the economic conditions of the country.
I fmd no justification for a downward revision at this time in monetary tar-
gets. Inflation is both low and stable. There is no evidence of any impending
acceleration. The inflation rate in 1992 was the lowest in the last 25 years but
one. If anything, the current jobs recession and the current problems in the fi-
nancial system argue for faster growth in the money supply, not slower.
Following the Fed's suggestion that we lower our targets would only com-
pound the policy mistakes of the past, and condemn millions of Americans to
continued unemployment.
It would be a sad irony indeed for the country to have voted to end the grid
lock in economic policy between the Congress and the President, only to find
it replaced with a new grid lock between an administration and the Congress
committed to stronger growth and a Federal Reserve restraining growth by
keeping its foot on tfie monetary breaks.
Thank you very much. Chairman Obey.
[TTie written opening statement of Senator Sarbanes is on p. 50 of the Sub-
missions:]
Representative Obey. Mr. Saxton, please proceed.
OPENING STATEMENT OF REPRESENTATIVE SAXTON
Representative Saxton. Thank you, Mr. Chairman.
It is a pleasure and honor to be here this morning with you, Mr. Chairman,
to hear your words of understanding about where we are relative to the
economy. And I am sure you will touch on monetary policy and a number of
other issues, which I will certainly be interested to hear about.
I hope in the context of your remarks that you will also remark relative to
other managers of fiscal policy which operate here on the Hill. I have recently
been privy to reading the results of one study, for example, which remarked
in some length and in some depth about monetary policy as it is carried out
here on Capitol Hill.
I just thought I would bring some of that information to your attention this
morning in the hope that you might, during the context of your remarks, com-
ment on it. This study covered a period beginning in 1965 through the current
fiscal year, and it basically talked about growth in government spending as a
percentage of GDP. It talked about growth in revenue as a percentage of
GDP. And it talked about something that we heard a lot about in this political
season, namely the growth in our deficit as a percentage of GDP.
It is remarkable that during that period of time our spending, as a percent-
age of GDP, has increased from 17.6 percent, according to this study, to 23.5
percent, or an increase in spending as a percentage of GDP of 33 percent.
At the same time, our revenue growth during that same period of time av-
eraged 1 8.6 percent, not growth but as a percentage of GDP. Our revenue
stayed roughly at that 1 8.6 percent, and as a matter of fact in the current fiscal
year our revenue is 1 8.6 percent, by coincidence just the average as a percent-
age of gross domestic product. At the same time, our deficit grew from two-
tenths of 1 percent to almost 5 percent, which is a fairly incredible and signifi-
cant growth.
So, while our revenues remain fairly level as a percentage, our spending
policies here on Capitol Hill increased by ahnost a third. I find those facts
very interesting, and I am interested to know during your comments if you
can comment on what you think that means.
I, Mr. Chairman, look forward to working as a member of this Committee,
and in conjunction with the new administration. I have said over and over
again that I would like to find places where, while I may disagree with some
basic policies of the new administration, I look forward to finding places
where we can work together.
And I remember very clearly during one of the debates when Mr. Clinton
was asked by a reporter what you thou^t of the Fed policy, and he said, and I
quote: "I think the Fed policy has been just about right." I am interested to
know, based on your conversations with members of the administration, if
that is still the case, or if this feeling that what the Fed has done is just about
right may have changed on the part of this administration.
Mr. Chairman, thank you. That was a brief statement, but I appreciate
again the opportunity to be here and look forward to hearing from you this
morning, Mr. Chairman.
Representative Obey. Thank you.
Are there any other members that have brief comments before we hear
from Mr. Greenspan?
Senator Bennett, please proceed.
OPENING STATEMENT OF SENATOR BENNETT
Senator Bennett. I simply want to make a very brief comment as perhaps
the newest member of the Committee.
Mr. Chairman, I heard you refer to Sears and IBM and General Motors,
and saying that Americans are used to seeing weak firms fail or lay people off
but not the crown jewels. I come to the Senate from an entrepreneurial back-
ground as the CEO of a company that started out with four employees, cur-
rently has a thousand, listed on the New York Stock Exchange and listed in
Fortune Magazine as one of the country's fastest growing firms.
I have a firm conviction that in terms of their management strength. Sears,
IBM, and General Motors could be challenged as weak firms, and that we
cannot put all of the job loss at the feet of governmental policy, however con-
venient that may be. American management has a responsibility for some of
the problems that we have.
It is my feeling, Mr. Greenspan, that the future of job growth in this coun-
try is going to be on the entrepreneurial side, and among the companies that
are listed in the Inc. 500, rather than the companies that are listed in the For-
tune 500. That is, it is the fastest growing part of our economy. And if you
can address that, I would be very grateful.
I realize the parochial interest coming out of my background, and maybe
the longer I am in the Senate I will leave that interest, but I felt I had to make
that observation.
Thank you, Mr. Chairman, for the opportunity, and I am delighted to be on
this Committee.
Representative Obey. Anyone else?
Mr. Greenspan, please proceed.
STATEMENT OF THE HONORABLE ALAN GREENSPAN, CHAIRMAN,
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Greenspan. Thank you very much, Mr. Chairman. It is a pleasure to
be before this Committee, and I must say, this is the first time I have seen so
many members, and I suspect that there is perhaps a renewed interest in eco-
nomics, which I certainly hope is the case.
As you know, the Federal Reserve will submit its semiannual report on
monetary policy to the Congress in just a few weeks, afler our upcoming Fed-
eral Open Market Committee meeting. At that time, I will be in a position to
address more specifically our expectations for economic growth and inflation,
and the ranges of money and credit expansion that we anticipate to be consis-
tent with the achievement of our goal of maintaining maximum sustainable
growth in the economy, by fostering a stable, noninflationary, financial envi-
ronment. Under the circumstances, my opening remarks this morning will fo-
cus primarily on identifying the major tendencies visible in our economy
today.
The available data suggest that economic activity has been increasing at a
firmer pace of late. After rising at only a 1 .5 percent annual rate on average,
over the first five quarters of the expansion, real gross domestic product in-
creased at about a 3 .5 percent rate in the third quarter of 1 992.
The advance estimate of the Bureau of Economic Analysis of the fourth
quarter's growth, which will be released tomorrow, is expected by many ana-
lysts to show a substantial gain as well. Meanwhile, industrial production
posted a healthy advance over the final three months of 1992, with solid
growth for a broad range of industries.
The recent news on the inflation front also has been quite favorable, as
businesses have continued their efforts to contain production costs and boost
efficiency.
Although a number of economic indicators are distinctly encouraging, this
is not to say that we have clear sailing ahead. As I indicated when I appeared
before this Committee last March, households and businesses have been
struggling to redress structural imbalances unparalleled in the postwar world.
TTie speculative bidding up of real estate and other asset prices over the
course of the 1980s fostered an excessive accumulation of debt and assets.
The subsequent weakening of asset prices in the early 1990s left the balance
sheets of manv households and businesses strained with debt overload. Banks
and other intermediaries that had financed the buildup had suffered losses that
had severely eroded capital. The pressures to work down debt, reinforced by
understandably more conservative lending practices, slowed economic
growth. Some time ago 1 likened these pressures to head winds of 50 miles an
hour.
Those head winds have now slackened somewhat, but they have not disap-
peared. The process of balance sheet adjustment, while becoming less of a re-
straint on the economy, will doubtless be with us for some time. In addition,
we are coping with a sizable retrenchment in the area of national defense.
And, although U.S. domestic demand appears to be improving, many of our
key trading partners are experiencing disappointing economic performance.
This is acting as a drag on our exports and our output.
Much of the strength suggested by the incoming U.S. data has been in the
consumer sector. The speedup in consumption comes after a period of more
conservative spending behavior when many households seem to have focused
on paying down debts and shoring up balance sheets so badly pressured by
the events of recent years. The relative strength of spending, thus, may reflect
the improvement that has been achieved to date in the financial health of
households. Debt-to-income ratios have fallen slightly, and debt servicing
burdens have declined quite noticeably, in large part because of the reduction
in interest rates. At the same time, the value of household financial assets has
been buoyed by the rise in stock prices last year. Moreover, concerns about
housing prices, which probably were a key reason that consumers were so
distressed for much of the past few years, seem to have lessened.
The strengthening of the housing market also may be important in a more
specific way. Sales of single-family homes have picked up and when existing
homes are sold, the capital gains that usually have accumulated over time can
be realized. The buyer of the home typically takes out a mortgage greater than
that paid off by the seller. The difference largely reflects the realized capital
gain of the seller who receives unencumbered cash, only part of which is ap-
parently added to a downpayment on a subsequent home purchase. Such cash
provides the seller with additional liquid funds to spend on consumer goods
and services.
History suggests that this is just what has been happening. The marked rise
in existing home sales in recent months has added to households' purchasing
power by enabling them to realize capital gains at an increasing rate, helping
to fuel the growth in consumer spending. Homeowners also have an opportu-
nity to liquefy capital gains when refinancing an existing mortgage, and refi-
nancing surged in the latter part of 1992. Realized or liquefied capital gains
are not taken account of in computation of the official saving rate, whose re-
cent decline therefore probably overstates the drop in the flow of saving as
perceived by households. However, unless home sales, mortgage refmancing,
and the associated equity extraction continue to rise, there is a limit to how
much longer this factor can fuel the growth of consumer spending. The meas-
ured personal saving rate is at a relatively low level, and fiirther outsized in-
creases in consumption are not very likely in the absence of a sustained
pickup in the income growth.
Consequently, a significant consideration in terms of the outlook for con-
sumer demand is the employment picture. The optimism revealed in the re-
cent surveys of consumer attitudes may prove fleeting if overall labor market
conditions remain subdued. Indeed, despite signs of modest improvement in
the past few months, since the recession trou^ in March 1991, employment
has shown essentially no net change on a payroll basis, and only a modest in-
crease in the household series.
Of course, the softness in employment in the current expansion is partly the
counterpart of another development — namely, a dramatic improvement in
productivity. Since the recession ended in early 1991, productivity has grown
at an average annual rate of about 2.5 percent, a better than expected perform-
ance given the relatively slow pace of the economic recovery to date.
The corporate restructuring and downsizing efforts that have been associ-
ated with the recent productivity gains have in part been a response to the
profit squeeze that emerged during the 1990-91 recession. They also have
been spurred by increasing costs of health insurance and other fringe benefits,
which have restrained hiring and encouraged a surge in the use of temporary
workers. But restructuring also seems to have reflected an effort to capitalize
on new opportunities for greater efficiency. Although we cannot be sure how
or why these opportunities have arisen, I suspect they are the product of the
accelerating advances in computer software and applications. Past large accu-
mulations of computer hardware did not seem to have the expected effects on
productivity. But a new synergy of hardware and software applications may
finally be showing through in a significant increase in labor productivity.
These far-reaching changes in the production processes in manufacturing
and in the means by which services are produced and distributed have appar-
ently yet to run their course, though one must assume that the pace of restruc-
turing will surely slow. Accordingly, we may see less of a tapering off in
productivity gains in coming quarters than past cyclical experience would
suggest. That prospect is highly favorable in terms of the longer run potential
output of the economy and our international competitiveness, but it also im-
plies some continuing adjustments in the work force in the near term.
The push to acquire state-of-the-art technology has also provided a dis-
cernible thrust to capital spending in recent quarters — ^and likely will continue
doing so. Real outlays for office and computing equipment have soared as
11
firms continue the transition to the more powerful and cost-effective ma-
chines that are now available, and purchases of communications equipment
continue to be boosted by, among other things, the shift to fiber-optic net-
works. Demand for other, more traditional types of equipment now appears to
be growing as well. The improved pace of economic expansion has doubtless
lifted sales expectations, and the marked increases in profits and cash flow
over the past year are providing funds for the new purchases.
Problems, however, remain in a number of areas, though with some lessen-
ing of concern. Chief among them are the ongoing difficulties in the credit
area. Depressed demand is doubtless the major explanation for weak loan
growth at banks and many other intermediaries. However, increased regula-
tion presumably has also played a role. Moreover, lenders seeking to protect
their capital positions have been extremely cautious. Although they seem to
have stopped tightening credit terms, a significant easing is not yet evident.
Commercial real estate has accounted for much of the asset quality prob-
lems at financial institutions. Until real estate values clearly stabilize, banks
and other intermediaries are not apt to become substantially more eager lend-
ers. The liquidity of real estate markets remains impaired, and lenders are un-
certain about the value of collateral and the appropriate level of reserves
against nonperforming loans. The risk that further reserving may be necessary
has led banks to bolster book capital, widen lending margins, and approach
new credits with caution. It is not necessary for real estate values to rise to re-
duce this risk, but lenders need to be more confident that prices will not con-
tinue to fall and that, if necessary, they can sell collateral expeditiously at
reasonably predictable prices. While there are some initial signs that commer-
cial real estate markets in some regions are finding a bottom, uncertainty re-
mains high. Having accumulated substantial liquid assets and rebuilt capital,
banks seem well positioned to meet increased loan demand, especially once
collateral uncertainty diminishes. Endeavors by both the Resolution Trust
Corporation and private parties to encourage the development of a secondary
market in commercial mortgages will help liquefy the market in commercial
real estate itself However, should problems in commercial real estate persist,
credit conditions for small and riskier business may ease only gradually for
some time.
Soft property prices, engendered by high vacancy rates and sluggish de-
mand for space, are likely to continue to restrain commercial construction
spending in 1993, and the prospects for multifamily housing are not much
better, hi addition, budgetary pressures on state and local governments remain
intense.
Meanwhile, we must continue to work through the sizable adjustment in
military spending that has been under way since tihe late 1980s. From a longer
run perspective, the defense cutbacks carry the anticipation of substantial
benefits for the Ij.S. economy.
Many of the countries of continental Europe and Japan have recorded only
weak growth. And in Canada and the United Kingdom, signs of recovery
from prolonged recession have ranged between weak and elusive. Our export
performance is thus being restrained by the developments abroad.
We at the Federal Reserve are seeking to foster financial conditions that
will encourage maximum, sustainable growth in the economy. As I and my
12
colleagues have stressed, a noninflationary environment is a precondition to
such a goal. For the coming year we will continue playing a constructive role
in supporting an extension of the recent, more hopeful signs of solid growth,
while endeavoring to avoid any excesses that might lead to a flare-up of infla-
tionary pressures down the road.
Such a course will help the economy emerge from the financial difficulties
of recent years, maintain the progress toward price stability that has been
achieved thus far, and thereby promote a sustainable economic expansion.
Mr. Chairman, I have excerpted from my full remarks, and request that the
full testimony appear for the record.
Representative Obey. Surely.
[The prepared statement of The Honorable Mr. Greenspan, along with an
attachment, is on p. 52 of the Submissions:]
Representative Obey. Thank you very much.
Let me say, Mr. Greenspan, that given the earlier remarks which created
the specter of a fearsome round of Fed bashing, let me simply say that I dont
really think that the public is interested in Fed bashing. Congress bashing. Re-
publican bashing, or Democrat bashing. I think what they are concerned
about is the fact thai they feel bashed. And they expect all of their officials,
elected and nonelected, to cooperate in designing a program to cease that
bashing over time.
And I want to be very frank. I think what you have now is a situation in
which one party, my party, has been put in control of the Presidency and the
Congress. The public now expects us to produce, and they expect, and they
believe, that we are in full charge of the levers of government. But as you full
well know, that is not quite so, because under our system of independence for
the Federal Reserve — a. system which by and large stood this country in good
stead over the years — the Federal Reserve has tremendous power throu^ its
monetary actions to either facilitate or to lean against and to some extent to
block or cancel out policy actions made by elected representatives in the Leg-
islative and Executive Branches of government.
I believe in the principle of Fed independence to prevent the elected offi-
cials from catering to irresponsible fiscal and spending pressures. But I also
believe that the Fed has a concurrent responsibility to respond to legitimate
public demands for policy changes, just as we have that responsibility.
Elections are supposed to not just replace people, but are supposed to send
messages from the public to us. I think the public has a right to expect that as
the old gridlock between the President and Congress slowly dissolves — I
hope rapidly dissolves — it is not replaced by a new gridlock between elected
political leaders and nonelected economic leaders in tfie country.
And that is why we want to seek responsible cooperation in pursuit of an
economic policy. And, I think, speaking very frankly, the problem is, and it is
partly by design, as you know, the problem is that there is a lot of uncertainty
on the part of members of Congress as to exactly what a Fed policy can be
expected to be in the next very crucial period.
As Senator Sarbanes pointed out and as I pointed out in my opening state-
ment, in a recent hearing before the Committee, a witness pointed out that be-
cause of rapid productivity growth — growth which you have mentioned in
13
your statement — the economy needs to grow at close to a 4 percent rate to re-
duce unemployment from the 7 percent plus level which we are now experi-
encing.
Yet, Paul Samuelson voiced concern in that hearing that if growth hit 3
percent or better, the Fed would probably allow interest rates to rise and
squeeze the money supply. Paul McCracken expressed concern that you
would "be fighting the last war" against inflation, despite the fact that it is 1
percent lower than it was the previous year, and despite the fact that it is at
historic lows with the exception of the one-year period that I have referred to
in my opening statement, that you would be fighting that war rather than help-
ing to boost growth.
And, frankly, there is some concern that you would be pursuing a policy
that is primarily aimed at bringing us closer to zero inflation, rather than mak-
ing sufficient room for moderate efforts to increase prospects of growth on
the part of the Administration, and that we would therefore be condemning
the country to continued high unemployment, to sluggish income growth, and
to reduced investment.
Can you assure us, because what I am very much concerned about is the
word on the very last page of your statement, when you said that a noninfla-
tionary environment is a precondition to the goals that you were talking about.
And that word "precondition" can have various meanings. Some p)eople are
afraid that that means that you are really determined to bring us much more
close to zero inflation before the Fed accommodates any effort to attack the
sluggish growth in the economy.
And so, I guess, I would simply ask you, can you assure us that you are go-
ing to be taking a more balanced approach than that? Can you assure us that
Samuelson and McCracken are wrong in their evaluation of your intent so
that we can have some degree of confidence that we will in fact have a coop-
erative relationship between the administration policy and yours?
Mr. Greenspan. Mr. Chairman, let me just say first that cooperation is al-
ready accelerating between myself and other members of the Federal Reserve
Board and the new Administration. I have met with a number of the people in
the Treasury Department, for example, and obviously Secretary Bentsen. In-
deed, I had breakfast wi^ Secretary Bentsen this morning. And we are dis-
cussing a variety of different elements about the economic outlook, both do-
mestically and internationally, and have pledged to coordinate our views and
systems as best we can.
As far as I can judge, the general thrust of the policy of this Administration
is not different from that which I expressed in my prepared remarks. That is,
to promote maximum sustainable growth over the longer run.
And the reason I raise the issue of a noninflationary environment is that
what we do not want to do is get into the stop/go type of instabilities which
have so characterized many of our periods in the past. Neither we nor Presi-
dent Clinton would basically subscribe to that view.
Now, when we get to the question of how does one implement that goal, it
obviously becomes an extremely difficult problem, because we are in fact
dealing with a period without precedent in the post- World War II period. As I
indicated in my prepared remarks, this has been an extraordinary period, and
one in which the usual processes of business cycle resolution have been
14
absent. And one need only look at the chart that Senator Sarbanes just
showed to give an indication of how different this particular phenomenon is.
When one looks at the productivity data and the restructuring that is going
on and the reshuffling of the whole system, it is really quite an extraordinarily
different type of economy than we have seen in a very long time, hideed, it is
the first time in my experience, which goes back several decades, that I have
seen anything like this.
And so it is incumbent upon the Federal Reserve and the Administration
to recognize that this is a different animal — and indeed, we all do — ^and to try
and find the appropriate policies which in fact achieve the goal of maximum
sustainable economic growth.
I might just say parenthetically, with respect to the quotations of what our
policy has been, there are a very substantial number of economists — those of
all persuasions, I might add — ^who think that we have been too easy. There is,
as you know, an organization called the Shadow Open Market Committee,
which basically follows the Fed very closely and has a number of distin-
guished economists who have in fact been claiming that because the adjusted
monetary base, which mainly includes reserves and currency, has been accel-
erating at a rate which would destabilize the economy.
Now, we don't agree with that. But I must say, we also don't agree with the
view that the appropriate money supply measure, or more exactly, the appro-
priate measure of financial conditions of the last two or three years is our
measure of IVI2.
What we do believe is that there is an extraordinary set of changes that are
going on which has made it very difficult to trace the processes of money and
credit in our system. And on the basis of fairly detailed analysis, we have con-
cluded that the changes that have occurred of late in M2 have temporarily,
hopefully temporarily, created that problem.
Representative Obey. If I could interrupt, because my time is almost up, I
guess what I am asking, and I would still like you to respond to it directly, if
you would, do you believe that if this economy were to in fact grow in the 4
percent range in the coming year, in real terms, would that be too rapid to fit
your definition of sustainable growlh?
Mr. Greenspan. I don't think one can make the judgment by looking at the
growth rate by itself You have to look at the collateral events that are occur-
ring with it.
I would say more importantly, we would be looking at the financial system
and whether or not credit growth is accelerating at an unsustainable rate, or
that the balance sheets are beginning to evolve in a way which would be-
come unsustainable. But specifically looking at the real growth rate per se, I
don't think is appropriate. That is, to answer your question very specifically, if
productivity is rising significantly, and if the economy is moving in a manner
which is not destabilizing, I can't say that there is any growth rate which I par-
ticularly think is inappropriate.
Indeed, I would like to see the maximum sustainable growth rate, and that
is what we will endeavor to be supportive of, as best we can.
Representative Obey. My time is up. I would simply say that I would agree
with you that we have to take a look at a number of factors in the environment
15
to determine what policy ought to be. And I guess I would just point out again
what some of those other factors appear to be, at least to me. I don't want to
clunk anybody in the head here, but as you can see, this obviously demon-
strates a ver>' different growth pattern, this time versus other previous reces-
sionary recover^' periods, in terms of employment.
We also, in terms of growth, in N42 real
Mr. Greenspan. If I may interrupt just for a moment. While the employ-
ment picture is an important issue, because of a technical problem that exists
in measuring M2, 1 would say that that particular indication of what is going
on in the financial system is somewhat distorted.
Representative Obey. Well, it is possible that that may be so, but nonethe-
less it certainly doesn't look like M2 is pressing on the upside at this moment.
Mr. Greenspan. I will also grant, if you had red on the upside and green on
the downside, it would look different.
Representative Obey. Another one of the factors that we hope you keep in
mind is simply that this is the comparison of real growth in the economy dur-
ing this period versus other previous recession periods, or recession-recovery
periods. As you can see, 1 .9 percent is considerably slower than the recovery
for other periods.
Senator Sarbanes has often used this chart to show what has happened on
the job front, the green line representing what has happened to the creation of
new jobs coming out of the recession for the average of previous recessions
versus what is happening today.
There is a variation of that, which I noted appeared in, I think, one of my
least favorite magazines, which indicated the variation in a little different
way, the recovery that began on November 1982 resulted in this trend line in
terms of job creation, very high, some 21 months out, over six million new
jobs created.
In March 1995, almost four million new jobs created. And as you can see,
minimal job creation here. So I think you can understand why we are con-
cerned.
Mr. Greenspan. That describes the dilemma that has been occurring in this
economy and in this recovery very well.
Representative Obey. I am sorry to take more than my time.
Congressman Saxton, please take your turn.
Representative Saxton. Mr. Chairman, I was interested in those charts be-
cause I have some that look similar to the ones that I have used in trying to ex-
plain my perspective — ^what I know about the economy — and I am interested
in your response.
I was particularly taken by the chart that Chairman Obey showed us,
which showed the difference between the economic growth that has taken
place in this recovery as opposed to the 1982 recovery. There is a tremendous
difference in the fiscal policy as set by the House and the Senate in the early
1980s and in 1990.
In 1981, 1982, and 1983, we set in force, before I got here, some fiscal
policy that was intended to propel growth. In 1990, we passed the Budget
Reconciliation Act, which in my view, contrary to what other people may
have thought, was going to severely limit growth.
16
And so, while Chairman Volcker and Chairman Greenspan have a similar
job to do, they certainly have a different economic atmosphere in which to do
the job. So the policies as set forth by the Fed today may be blamed for slow
economic growth by some, and by some others we may look at Capitol Hill
and at the economic policy that we put in place, which is certainly different
than it was at the inception of the growth line in 1982. 1 would just be inter-
ested in your response to that different perspective.
Mr. Greenspan. Congressman, I must say that the causes of the recession
of 1990 and 1991 were tiie subject of a panel at the American Economic As-
sociation a number of weeks ago, and the general conclusion, if one can say
that that was possible among a group of economists, is that it was very diffi-
cult to judge.
The major conclusion that did emerge was that there seemed to be a spon-
taneous reduction in consumer spending, and that neither monetary nor fiscal
policy appeared in the evaluation of most of the people who were talking on
this particular subject. And I do think that the issues you raise are ones which,
in retrospect, evaluators of business cycles and economic trends are going to
be looking at somewhat closely.
And I say, from this perspective, it is probably too soon to fully know pre-
cisely how it will come out, because we haven't yet fully seen ^e develop-
ment of this particular cycle. It is only when we see how this cycle works its
way through that we will get a better perspective on both those periods.
Representative Saxton. I thank you for that very clear response, and I did-
n't mean that to sound facetious. Your job is a difficult one — and some would
say ours is too — in your formulation of what the Fed is going to do relative to
monetary policy.
At any given time, you certainly have a number of factors to take into con-
sideration. Some are national in nature, some have to do with world trade,
some have to do with the economies of other countries, some have to do with
the performance and growth of the economy around the world, and a lot have
to do with domestic issues, a lot have to do with — as you very well stated ear-
lier— the consumer expectation of what consumerism ought to be based on,
what individuals and the economy are thinking and all of those things to-
gether, the desire to buy homes or the lack of it. How do you factor all of
Siose elements together and then put it together again with what we men-
tioned before — fiscal policy established by the House of Representatives and
the Senate and the Administration? That must be a tremendous undertaking,
to factor all of those things together.
Mr. Greenspan. It is, and regrettably we don't have what seemed to be the
type of stable set of relationships which enabled economists to think that we
could, perhaps, with some degree of the hope rather than reality, to make
judgments of the appropriate balances of fiscal and monetary policy, with
relatively simple analyses.
Indeed, in the early part of the post- World War n period, econometric
models were developed, which seemed to work fairly well for a while, and
gave us a fairly good judgment as to the structure of forces that were engen-
dering how the economy behaved, and therefore how both monetary and fis-
cal policy would both function in a manner to contribute to the maximum
economic and employment growth.
17
That clearly has broken down to a large extent, and the nature of the
changes that are going on has meant that the t>pe of economic structure, the
set of forces which are driving this economy today, and the world at large, is
somewhat similar to the past, but enough different that we have to struggle to
find what those relationships are, sometimes very crudely, sometimes inaccu-
rately.
And what we are hoping to be able to do is to find a structure in which we
can hopefully sense that we know why these various connections are occur-
ring and be able, basically, to get a sense of the appropriate policies that will
create maximum sustainable growth.
What we do now is to look at an extraordinarily wide variety of things and
try to essentially judge how the financial and economic systems are interfac-
ing, and it is that which drives our policy.
Representative Saxton. Mr. Chairman, I am told my time has expired, but
I would just like to conclude with one instance — which sums up what I have
tried to say in my questioning — ^which is to demonstrate that while the Fed is
certainly an integral and important part of our national, fiscal and regulatory
system that makes things happen, positive or negative, it is only a part, and
what we do on Capitol Hill is also a part, and an important one. And what
happens around the world is a part, and an important part, and the domestic
factors that play their roles are important elements as well.
So I thank you for your responses and your explanations, and I look for-
ward to talking with you further, perhaps, a little later.
Mr. Greenspan. Thank you.
Representative Obey. Senator Sarbanes, please proceed.
Senator Sarbanes. Thank you very much, Mr. Chairman.
Chairman Greenspan, welcome to the 103rd Congress. We look forward to
seeing a lot of you in the next few weeks. When is tfie Open Market Commit-
tee going to meet?
Mr. Greenspan. Next Tuesday and Wednesday.
Senator Sarbanes. Good. I am pleased you are here today.
To lay the predicate for my questioning, I want to very quickly go through
a series of charts. You have seen some of them, but I want to lay a couple of
others out too. The first one is on the jobs recession, and the extraordinary
contrast between the lack of recovery in terms of jobs in this recession, com-
pared with other recessions in the postwar period. (See chart below).
7.0
■1.0
18
Job Creation
After the Past 3 Recessions
0 1 2 3 4 5 6 7 8 9 10 1 1 1 2 1 3 14 1 5 16 17 18 19 20 21 22
Months of Recovery
Source: Bureau of Lebor Statletlca. Joint Economic Committee
And I have a comparable chart on GNP growth, which again, we had 8.4
percent average on growth, 2.9 percent thus far in tliis recovery, so there is a
very marked gap there. Of course, that gap is reflected in terms of what is
happening in jobs, and as we can see this recovery is weak and anemic on the
jobs. We still have a jobs recession; we are not putting people back to work,
and I don't think anyone can really contest that, compared with what hap-
pened in previous recessions. (See chart below).
Growth of Real Gross Domestic Product
Following Post-War Recessions
+ 8.4%
/
/ 5.5%
Gap
Avftrago of 4 /
Prior Recession- y
Recovery Cyclee^r
/ y
S
/ ^ +2.9%
/ •
/ ^
/ •
^ ^__ „. Current Recesslon-
^r ^ ^ Recovery Cycle
108%
O' 106°
O
C 104%
0)
o
Q.
102%
100%
T-3 T-2 T-1 Trough T+1 T + 2 T + 3 T + 4 T + 5 T + 6
Quarter from Trough
Source: U S. Department of Commerca, Joint Economic Committee
Now, the Federal Open Market Committee made projections about the un-
employment rate last year. This was your range. Of course, you always use a
range. The wider you make it, the more likely it is to get within it.
I am going to pass on a little story that Paul McCracken told us about be-
fore we finish. But this was your projection of the unemployment rate, and
this is where we are. So unemployment has been a more serious problem than
the Open Market Committee projected it would be.
Now, if you ask the question, why is this recovery so different, why aren't
we coming out of this recovery, and you try to search for explanations, it is a
complicated problem. I am prepared to concede that. And there are important
structural changes that are taking place.
But I can't help but think it has some relationship to monetary policy, and I
am going to show you a couple of charts, and I am going to throw some
quotes at you from some very distinguished economists.
This is the Fed's target range for M2 growth. In 1991, you were barely
within the range. We have done it for 1991 and 1992. And in 1992, of course,
you are below the 2.5 percent. (See chart below).
20
M2 Relative to Federal Reserve Target
Seasonally Adjusted Annual Rate
$3,700
$3,600
(A
C
~ $3,500
m
$3,400
$3,300
Nov Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov
1991 1992
Sourca. F«d©f«l Reierva, Joint Economic Committee
Now, you are talking about lowering it to 2 percent, which I guess would
get you within the range. That is one way of doing it, of course. You don't
make the target, you just lower the range.
Now, remember the previous chart about the difference in recovery in this
recession. Now, this shows, if you start searching, an absolutely marked con-
trast with the growth of real M2 in this recovery compared with previous re-
coveries in the postwar period. In fact, we have got a minus figure in this
recovery. Previous recoveries, anywhere from 6 to 16 percent. (See chart be-
low).
21
Growth of Real M2
During First 20 Months of Recovery
20.0%
1 S .0%
10.0%
5.0%
0.0%
-5.0%
1954-55 1958-59 1961-62 1970-72 1975-76 1982-84 1991-92
Recovery Period
Sourca: U.S. Depirlment of Commerc*. Joint Economic CommittaB
I know the Fed is now pushing the technical explanation — I do not want to
put the whole argument on the money supply, and we can argue about
that — but in the testimony before our Committee on December 30, we had
Paul Samuelson, who came in with a very strong statement. He and Jim To-
bin have both been sharply critical of the Fed's monetary policy and essen-
tially asserted it is too little and too late. Both Nobel Prize winners. You may
say they come from a certain point of view.
Martin Feldstein wrote in a Wall Street Journal'.
The monetary growth targets should be raised by a third to assure a vi-
able recovery.
Milton Friedman, in October of this past year, in a Wall Street Journal arti-
cle entitled "Too tight for a strong recovery," said, and I quote:
The Fed's inflation objective is close to being achieved. Indeed, the Fed
has temporarily overshot continuation of M2 growth at 2 percent per year
would imply actual deflation, not negligible inflation. Given its departure
from its own policy, the Fed now needs to speed up sharply monetary
growth to bring M2 back to its target range and then hold it there.
Paul McCracken said:
The basic drag on the economy, however, more than anything else, ac-
counting for the unusually anemic expansion of output and employment
22
since early last year, is an insufficiently expansive basic monetary policy
in 1991 and 1992.
Now, that is a broad range of very eminent economists. In fact, it covers
the spectrum, frankly, of people who are in agreement in criticizing the Fed's
monetary policy. We have had a dialogue over the last couple of years in
terms of whether the Fed has been behind or ahead of the curve, and I think
you have been very much behind it.
A year ago last Christmas, you gave us a Christmas present when you
made a sharp drop in the rates, when you finally began to catch up with Fed
policy in previous recessions.
Now, I am deeply concerned about the Federal Open Market Committee
minutes in the last meeting indicating that you are thinking of tightening up.
That would just cut this possible recovery off at the knees.
You come in and urge the Congress not to do an expansive fiscal policy.
But if you have a restrictive or contractionary monetary policy, you don't pro-
vide the offset we need in the monetary area in order to have the kind of fiscal
policy that you want. You are going to, in effect, provoke, perhaps, the very
thing you assert that you don't want.
Now, I know we are trying to explain away this M2 thing. I am prepared to
look at the case, but I have some doubts about it, and I am reminded of the
statement that Paul McCracken made when he appeared at our hearing on
December 30. He talked about the proposal to lower the target rates. This is
what McCracken said. This is not me talking. I am quoting President Nixon's
chairman of the Council of Economic Advisers and a member of the council
under President Eisenhower.
Federal Reserve policy reminds me of that old story of the man who
stopped for gasoline at a station and noticed the target on a building with
a bullet right through the bull's eye. And he said. My word, who is the
maiksman who can hit it that way? And the station attendant said. He is
the village simpleton and he is standing right there; ask him how he does
it. And so he was asked and he said. Why, it is veiy simple. I shoot the
gun and then I draw the target right around it.
Now, I have a suspicion that this is what the Fed is in the process of doing
when it talks about lowering its rates.
In your response to Chairman Sasser of the Senate Budget Committee, you
said:
I will be circulating your letter to the other FOMC members so they will
be fully aware of your views when they consider the ranges at their next
meeting.
Chairman Sasser expressed many of the same concerns I am expressing
here this morning.
So the first question that I want to put to you is a very procedural one, and I
want to defer to you so you can respond to the presentation that I made. The
Fed got in touch with us immediately after this Committee's hearing on
Wednesday, December 30, with Paul Samuelson and Paul McCracken, and
with Lee Hoskins, a member of the Federal Open Market Committee.
I have to be careful because I recall at one point that you had to fly to Chi-
cago in a late-night meeting in order to get a dynamic going that would enable
23
the board to ease monetary policy at that time. Of course, that is a problem
you have, in terms of the dynamics of the Open Market Committee itself But
to be fair, we brought in someone with a very different viewpoint. That is all
contained in the transcript of the hearing.
So the first question I would put to you is whether this hearing transcript
has been circulated to the other members of the FOMC, and if it hasn't been,
can it be?
Mr. Greenspan. I believe it has. Yes, I have seen a distribution list on it,
and it has been.
Senator Sarbanes. My second question is, at the unemployment hearing
on Friday, January 8, with the Bureau of Labor Statistics, we developed at
some length both the difificuit unemployment situation, which continues to
exist, and we also developed the very positive record on the inflation front,
and pressed the point that by any objective standard the problem facing the
economy now is economic growth and jobs, and not an inflation threat. We
always are concerned about inflation, but I dont think in the current context it
can be given a primacy.
And I would also ask you that the transcript of that hearing be distributed
to the members of the Open Market Committee, if it has not yet been done.
Mr. Greenspan. That is January 8?
Senator Sarbanes. That is the latest hearing with the Bureau of Labor Sta-
tistics on the unemployment figures and on the price level.
Mr. Greenspan. It was on the day of the release of the unemployment re-
port?
Senator Sarbanes. That is right, Friday, January 8.
Mr. Greenspan. We shall see that that gets done.
Senator Sarbanes. I appreciate that very much.
Now, what about this problem? Can we get from the Fed a sufficiently ac-
commodating monetary policy in order to get some economic growth and job
restoration going? How serious are those minutes of the November meeting,
which suggest that the Fed in this context is going to start to tighten monetary
policy?
Mr. Greenspan. I disagree with your interpretation of what those minutes
state.
Senator Sarbanes. Well, that is a good start. I am pleased to hear it.
Mr. Greenspan. Indeed, I indicated to Senator Sasser in my response to
him, the issue that we were confronting in those discussions and which was
reported in those meetings was a problem of deciding what one does if it is
our conclusion that the particular construction of M2 in this environment,
with this very sharply sloped yield curve, with a number of other aspects of
the financial system suggesting that M2, which has served us so well as a
proxy for the financial system, has veered off in a manner which is no longer,
at least at this particular time, an appropriate proxy for what the financial sys-
tem is in fact doing.
Therefore, the question is obviously, one, do we redefine M2? I would sug-
gest that that is not a desirable thing to do, because I hope at some point, as it
has in years past, it will reassert itself in a more stable manner. Two, do we
recognize that there is a temporary problem with M2, and one which has
24
created a very dramatic change in the relationship between nominal gross do-
mestic product on the one hand and M2 on the other, and make our adjust-
ment of the ranges to accommodate that view?
Let me just say, in the context of the chart which you showed about our
forecast of the unemployment rate, the actual nominal gross domestic product
that we were forecasting in that context came out reasonably well. Indeed, I
would say that the real gross domestic product that has emerged in 1992 is
probably in excess of what we would have expected.
So what we were observing in the November meeting was a phenomenon
in which economic growth, the level of real activity, was moving along at a
reasonable pace, but the M2 that we expected to be associated with it, at a
level which would be parallel, indeed declined very significantly for technical
reasons. So that was the context of that conversation that we were having at
the FOMC, and indeed what we reported in the minutes was a reflection of
how to handle this technical problem.
Senator Sarbanes. I am not sure it is a technical problem. I am not pre-
pared to concede that. If you came in here this morning and said, we perceive
a growth in money supply and an expansion in the economy, and a recovery
of jobs, and an acceleration of the inflation problem, that belies where the
money supply has been, and therefore we think there is something wrong in
our calculation of the money supply because we are not even at the bottom of
our range, and yet we are getting tremendous economic growth, we are get-
ting tremendous job restoration, we are beginning to get an accelerating infla-
tion problem. There is something amiss here, and we have begun to analyze
this thing and have concluded that there is a big technical problem, and tiiat
somehow the monetary policy is working to provide a stimulus as reflected in
these various factors that I have talked about, and therefore we are going to
have to rethink how the money supply works— that is not what is happening.
You are out of your range. You are below your range. These other econo-
mists are sharply critical of it. The economic growth is far less than in previ-
ous recoveries. The job restoration is in marked contrast. There is no inflation
problem. In fact, the performance there is the best it has been in 25 years. You
are out of your target range, and you are saying, "Well, we have to rede-
fine"— ^you are going to redraw the bull's eye, just like in that story I told. Is
not, maybe, the problem your failure, in effect, to get a monetary policy that
will accommodate the possibilities of economic expansion?
Mr. Greenspan. Senator, you are not going to get me to criticize a group of
old friends of mine. I happen, in this particular case, to disagree with them.
Senator Sarbanes. Well, they have been criticizing you, so it is fair game.
Go ahead, please.
Mr. Greenspan. I don't think they are criticizing me. I think they are criti-
cizing the system; they are criticizing policy, which is surely their appropriate
role. I could array for you a whole series of people who think we got it wrong
in the other direction. It is a very difficult issue, which we are all endeavoring
to make a judgment on.
I will tell you this, if you take the implied economic models which are in-
volved with those who basically are saying that the growth in money supply
is going to create some significant problems or has created significant
25
problems in the economy, those models cannot explain the levels of eco-
nomic activit>' that have emerged in the second half of 1992.
Senator Sarbanes. My time is up, and I don't want to abuse my colleagues,
but I am not relating, at all, to the money supply.
Mr. Greenspan. The action is on the interest-rate front.
Senator Sarbanes. The fact of the matter is, we have a recovery that is not
restoring jobs, that is not responding. We have to get this economy moving. If
the Fed doesn't respond, it is going to increase the pressure on the Congress to
respond on the fiscal front, which is constantly what you assert you don't want
to see happening, and you ma>', in fact, precipitate the very course of action
you warn against by not having an adequately accommodating policy.
We want that message to go very clearly to the members of the Federal
Open Market Committee. In fact, I am beginning to think we ought to bring
all the members of the Federal Open Market Committee in here for some of
these hearings. A good number of them never appear before the Congress be-
cause they are selected by private interests and not nominated by the Presi-
dent, not confirmed by the Senate, unlike you, who has to go through that
process.
But I am going to defer now. I appreciate the commitment to get to all the
members of the Federal Open Market Committee the transcript of both of
these hearings — the December 30 hearing on monetary policy for 1993, and
the January 8 hearing on the latest unemployment and price figures.
Senator Bennett, please proceed.
Senator Bennett. Thank you very much.
This won't be nearly as stormy. It is my understanding that we went into
this recession with the lowest level of inventory buildup that we have ever
seen in a postwar recession. Is that a correct statement?
Mr. Greenspan. Well, I do think we have seen a fairly dramatic decline in
the ratio of inventories to sales as the efficiency of the system has so im-
proved that the abnormal inventory accumulations that so plagued us in the
past clearly are not evident in this period.
Senator Bennett. It would occur to me, then, that the fact that we went
into this recession without that kind of inventory buildup to begin with,
which, if we were to put it on a chart it would be "normal," means that as we
come out of the recession, we don't have the inventory buildup engine to
cause people to be hired back, brought back to work at General Motors, or
wherever, and that those jobs are gone, and they are gone forever. Just be-
cause we have eaten through inventory doesn't mean that we bring the work-
ers back to General Motors to build more Chevrolets and Pontiacs.
The efficiencies of the system are causing parts of Chevrolets and Pontiacs
to be built in Canada or Singapore or Mexico or wherever, and those jobs are
gone and they are not coming back just because of something the Fed may or
may not do. It is a structural thing, which I think you referred to when you
said the models have broken down and the types of structures are very differ-
ent from the past. Is that a fair opinion on my part?
Mr. Greenspan. I would say that the Federal Reserve policy obviously does
have an impact in conjunction with policies of the Federal Government's fis-
cal operations to effect levels of economic activity', and thus indirectly to
26
affect different industries. But it is certainly the case that actions taken by the
Federal Reserve cannot directly impact on what the operations of a particular
plant or particular industry will be.
Senator Bennett. So, as we move more and more into a global economy,
as we move into an economy more dominated by service industries than
manufacturing industries, we get to the point where the old models don't work
because the economy has changed. It is not broken in the old sense; it is
changed in a very new sense, and we need to recognize that.
I think I hear from what you are saying that you do recognize some of
those forces that are working in the direction in order to give us models that
can more accurately predict the future than the old models would have been
able to do?
Mr. Greenspan. That is correct. Senator.
Senator Bennett. That is very encouraging to me, because I see no point in
wishing for the old days. Bad as they may have been, they had some predict-
ability to them. We have to recognize that in the changed economy, that pre-
dictability is going to go, and we are all going to look bad if we try to use old
models to predict new patterns.
Let's talk about the role of technology and productivity for a minute, be-
cause fi"om the days of the Luddites, technology, whether it is spinning
wheels or PCs, have always threatened existing jobs, at least in some people's
minds who don't recognize that ultimately they create far more jobs than they
destroy.
Some of the crystal ball gazers are saying, we are going to see a revolution
from fiber optics and satellites and things of that kind, will be as great as the
revolution of the invention of the PC. Do you see anything like that on the ho-
rizon, or is that beyond the purview of an economist, and we are both here
speculating?
Mr. Greenspan. No, I think it had better be in the purview of economists,
or we are going to miss the boat, so to speak.
As I have testified before this Committee in the past, and certainly before
other committees of the Congress, over the years we have been watching the
structure of the gross domestic product as it moves from what it was, say, at
the turn of the past century — a heavy industrial-based type of activity, where
the physical bulk of the GDP was a crucial issue — ^to one in which the pro-
portion of the gross domestic product, which are ideas as distinct from physi-
cal volume, has become an increasing part of the real economic value added.
And that is an irreversible process. In other words, we do not lose knowledge,
and technology continuously advances. And what occurs as a consequence is
that the specific gravity of the GDP goes down relative to real value.
That is the reason why, incidentally, we have such an increase in trade
across borders. That is, goods are lifter, which means they are easier to
move, and therefore easier to move across borders, and that is why the global
economy has become a realistic concept.
That process will continue, and we will see that an ever increasing propor-
tion of what it is that we create is of an impalpable nature, and whether or not
it is a big shift from heavy copper wire to lighter fiber optics, or whether we
are shifting from the old vacuum tube to the microprocessor or something
27
related to communications, that is an irreversible, continuing type of activity.
And I would suspect that if we could reproduce the American economy of,
say, 2020, we would find it really quite different from where it is today.
Senator Bennett. I find it significant that the richest man in the United
States right now is Bill Gates, who owtis no huge factories or ranches, no tre-
mendous commercial enterprises that we would think of 50 or 60 years ago. It
all comes out of his head. And the intellectual product has made him the rich-
est man in the United States, not the physical product of a steel mill or of an
automobile factory. And I think that is a demonstration of the kind of struc-
tural differences that we have.
One last question. I have heard some economists say that what we have
really had in the 1980s is a speculative binge similar to tulip mania among the
Dutch a few centuries ago, whether it has been the Wall Street activity or real
estate activity and things of that kind, and we are coming out of the lift of that
speculative binge.
We have seen the Japanese real estate prices and stock market prices lose
something like two thirds of their paper value, which would lend credit to the
idea that we have had such a speculative binge. One of the things that fueled
it was the fact that the effective cost of capital in Japan was zero because of
the way the thing was structured, and you understand that better than I.
Is there any chance, if we were to push interest rates in the United States
still ftirther down, that we would get to the point where the real cost of capital
might be zero in America, and fliel anything of that kind on our part?
Mr. Greenspan. Well, there is a dilemma here in precisely whether we are
defining the cost of capital in a short-term or long-term sense. It is in fact the
goal, or should be the goal, of economic policy, or at least one aspect of it, to
create the lowest real rate of long-term capital cost.
In short, what we ought to try to do is to remove the risk from the cost of
capital and essentially get the lowest real equit>' cost of capital that we can
get, because what that will do is enhance the growth in capital investment and
increase standards of living.
That is the general goal and is the reason why I raise the issue of a nonin-
flationary environment being a precondition for maximum sustainable eco-
nomic growth; that is, basically the lower the real cost of capital, other things
equal, the greater will be the growth rate.
But there are occasions when we try in the financial system to drive the
cost of capital down either by a big bulge in stock prices or by sharp declines
in interest rates which cannot be sustained in the longer run, and that is not
the same thing as reducing the long-term real cost of capital. That is a forced
type of activity which in fact has too often in the past, both in the United
States and elsewhere, created a stop/go type of environment.
The example to which you alluded to— the Japanese bubble in the mid- to
late 1980s — has to be differentiated from setting the broader question of the
desirability of getting the real long-term interest rate at its lowest sustainable
level and the real cost of equity capital also at that level.
And policy that is directed to accomplish that would achieve as much as I
can imagine to create long-term sustainable growth, in the context of the tech-
nological advances, which are so crucial to economic growth.
76-207 0-94—2
28
Senator BENNrnr. TTiank you very much. My time is up.
Representative Obey. Senator Bingaman, please proceed.
Senator Bingaman. Thank you very much, Mr. Chairman.
Mr. Greenspan, would you just clariiy for me two factors that, I think, need
explaining. One is that we have a lower growth rate as we are going through
this recovery. We have a lower rate of increase in our growth than we have
had in previous recoveries. And that relates to what our fiscal and monetary
policies ought to be.
A second and somewhat distinct issue, I believe, is that even for the rate of
growth we have, we have too little job creation. And I guess I would like you
to address that second point.
Is this new animal that you referred to — this new economy — as part of
that, we could actually have what we would think was, by historical recollec-
tion, a reasonable rate of growth and still not have job creation at a level that
we need? Is that the situation we are in, and if so, why?
Mr. Greenspan. Senator, you have to differentiate between short-term and
long-term patterns. What we have been observing in the last year and a half is
a very dramatic increase in productivity, well in excess of what we would
have expected with this type of tepid economic growth that has occurred.
If that continues, that is saying two things. One, we have underestimated
the potential long-term economic growth of the economy; that is, in fact, it
can grow faster than most economists have recently been forecasting. In
short, if you assume that, as a lot of economists do, say, productivity growth
over the long term is expected to be only 1 percent a year and it turns out to
be significantly more than that, then clearly the potential growth rate of the
economy is quite significantly higher. But there is no reason in that environ-
ment why employment growth cannot also rise.
What it will mean, essentially, is that both real growth and employment
rise, but in this particular period it is important to recognize that this is a very
unusual phenomenon, and we are not quite sure yet whether to take this pre-
sumed cusp in productivity as being other than just a short-term phenomenon.
If it is a short-term phenomenon, and the growth rate continues where it
has currently been in the last half year, then obviously productivity will slow
down and arithmetically that means that employment growth must accelerate,
and in fact accelerate quite significantly.
We dont know yet exactly how that is going to emerge, but I should say to
you that in either case, employment growth, if this economy is continuing to
grow, will doubtless pick up from its extraordinarily slow pace of the last sev-
eral years.
Representative Obey. Senator, will you yield on that point for a second?
I just want to use this chart to demonstrate that I am somewhat dubious
about the suggestion that productivity increases are really important in this re-
spect, at least as important as you indicate. Certainly we are experiencing an
increase in productivity, but as this chart demonstrates, coming out of previ-
ous recessions, productivity normally increases, and in fact if you take a look
at the rate for the 1991-92 so-called recovery period, that certainly is not
higher than it has been in previous comparable recovery periods. (See chart
below).
29
Recent Productivity Normal for Recovery
Change, 6 Quarters from Trough, Annual Rate
5.0%
4.0%
3.0%
2.0%
1 .0%
0.0%
■54-55 '58-59 '61-62 '70-71 '75-76
Recovery Period
'82-84
'91-92
Sourca: Bur«au of Labor Statlatlca. Joint Economic CommHta*
Mr. Greenspan. If you adjust for the fact that the recovery has been very
slow, it is clearly well in excess of what one would expect. The major deter-
mination
Representative Obey. Why would companies want to lay off people so
they get more out of each worker without tiying to get more out of the work
force? Why should we be surprised about that?
Mr. Greenspan. If one looks at those earlier periods, what you will find is
that overall economic growth was very significant during that period, and that
productivity growth was only a modest part of the total growth. Indeed, one
way of looking at the increase in employment in the earlier periods was basi-
cally that.
What is different about this particular period is that all of the economic
growth is a consequence of productivity increases, and when you try to deter-
mine what productivity is going to do, the levels of economic activity are a
very crucial determinant of that. And when the economy is growing very rap-
idly and fixed costs fall per unit of output, productivity naturally rises very ex-
traordinarily.
What is different about this period is that you have, if you look at your
chart, strong productivity growth, despite the fact that the growth in overall
output has been extraordinarily modest. And that is the issue which I think is
crucial here.
30
Representative Obey. I don't want to interrupt further. I am sorry.
Mr. Greenspan. Let me make one final point. If productivity had followed
its normal relationship to output in this recovery, employment growth would
have been significantly higher.
Representative Obey. I will get back to that point later.
Senator Bingaman. Let me ask about one other issue. Could you say any-
thing or tell us anything about how the very large and chronic trade deficit
that we have today and have had throughout most of the 1980s, how that has
changed our ability to pull out of this recession, and in particular how it has
affected our ability to begin creating jobs at a reasonable level as this recov-
ery has taken off?
Mr. Greenspan. Senator, I don't think it has had much of an effect, because
remember that it was only a few years ago that the unemployment rate was in
the low 5 percent range. At that time we had a very large trade deficit. So it is
difficult to draw the connection between the two in that context.
There is no reason that I am aware of why that would be a particular drag
on our economy if foreign investors are willing to finance the current deficit.
Obviously, if that were not the case, if foreigners did not wish to buy our gov-
ernment and private securities, then it would affect our recovery, but there is
no evidence of that even remotely.
Senator Bingaman. My impression was that throughout the last half of
1992, we kept hearing that the recovery was being led by exports, and I guess
that it strikes me that, for some of the reasons you state in your prepared state-
ment, export growth has stalled, and it does not look as though that export
growth is going to provide a major impetus to an additional strengthening of
tiie recovery in the future.
Mr. Greenspan. I think that is right, Senator. Our exports were doing ex-
ceptionally well, and we were increasing market share in the world largely
because our productivity was better than one would have expected, and the
efficiency and our international competitiveness have very clearly been im-
proving.
But, remember, the overall outlook for the rest of the world for our trading
partners has deteriorated quite significantly. Indeed, at this stage the United
States stands out as being the one major industrial nation whose economy is
doing reasonably well.
But another way of looking at that is, our foreign markets are doing less
well, and one must assume that we just can't continue to increase our market
share indefinitely. And I would suspect, as indeed all forecasters do, that the
weakness among our trading partners will feed back into a less viable foreign
sector for the American economy.
Senator Bingaman. So we will see a larger trade deficit in the next year
than we did in the last?
Mr. Greenspan. If the American economy continues to improve, and the
rest of the world remains weak, then one could expect that our imports would
rise relative to our exports. That would be the normal expectation that one
would assume if the United States were doing better than our trading partners.
Senator Bingaman. [Presiding.] Senator Craig, please begin your opening
statement.
31
OPENING STATEMENT OF SENATOR CRAIG
Senator Craig. Thank you very much, Mr. Chairman.
Chairman Greenspan, welcome to the Committee. I apologize for not get-
ting here earlier.
I am pleased you had breakfast with Secretary Bentsen this morning. I
hope this is an omen of better things to come.
I say that in the context that I noticed in your background that you were
once a saxophone player.
Mr. Greenspan. I have tried to hide that, but not successflilly.
Senator Craig. In the Henry Jerome orchestra. Can I suspect that maybe
you are going to be allowed to be first chair of the new sax section down-
town?
Mr. Greenspan. May I offer no comment?
Senator Craig. Having said that, I also noted this morning, this Committee
was awfiilly quiet about a certain kind of deficit that is generated here on
Capitol Hill in large amounts, so I would like to direct at least a portion of my
questions, as it relates to your role in that deficit.
Our Administration has, for a time, at least, talked about short-term eco-
nomic stimulus versus the need to begin any immediate long-term deficit re-
duction program. I know they have changed a bit as new figures have come
out. Do you buy the argument that deficit reduction undertaken too fast or too
soon could actually hurt the economy at this time?
Mr. Greenspan. Senator, I find that noncredible, if I may say, if for no
other reason than it is very difficult for me to perceive passage by the Con-
gress of a sufficiently restrictive budget to create the degree of so-called fiscal
drag, which would be overwhelming. I would almost say that I would like to
believe that were possible.
Our problem is really on the other side, on the difficulties in reducing this
deficit. But the necessity of doing that, because of the long-term rise in the
deficit which CBO indicated to Sie Congress yesterday, or the day before,
suggests to me that the problem of getting the deficit dov^ is going to be ex-
tremely difficult, and if we keep in the back of our minds that we should be
very carefiil not to overdo it, we are going to find that we will make the job
more difficult.
There is no question that theoretically one can create a cut in the deficit
which is, in a sense, overdone. That is, it creates fiscal drag and will have a
negative impact on the economy. I find that highly theoretical in today's con-
text, and I would hope that that fear not restrain the hand of the Congress in
adjusting the long-term deficit to where the real problem lies.
Senator Craig. In that context, to what extent do you consider a major
deficit reduction package, in part, a prerequisite to a monetary stimulation?
Everybody wants to talk about stimulating, yet nobody wants to talk about
deficit reduction. It seems like there has to be some hand-in-glove here.
Mr. Greenspan. Obviously, if there is a significant package which the mar-
kets perceive as credible, and as a consequence long-term interest rates begin
to move down, as indeed they did on Monday in expectations of such an
event, then clearly the financial system itself begins to ease, as long as policy
adjusts to that. But it is a much more complex set of relationships than just
32
saying the budget deficit has been reduced, and therefore certain things hai>
pen in monetary policy. In formulating policy, it is clearly an important aspect
of what it is that we respond to and what we react to. But to assume that, as a
number of people do, there is a simple relationship, or simple tradeoff, really
is a view of the way the system worked, perhaps, 30 years ago when econo-
mists used to believe that there was a very simple tradeoff between fiscal and
monetary policy without considering the fact that what we have learned in re-
cent years is how important inflation expectations embodied in long-term in-
terest rates are to economic growth.
In that respect, I would say that there is not a bilateral relationship, it is tri-
lateral, in the sense that we all have to observe what the total process is and
try to find the most appropriate set of policies which lead to sustainable
growth.
Senator Craig. With government borrowing, right now, consuming all
private-sector savings and retained corporate earnings, or the equivalent
thereof, aren't we really setting into place a very difficult set of circumstances
that would tend to create very flat, long periods of low ^owth without the
kind of capital necessary to invest in the marketplace to get it moving?
Mr. Greenspan. Senator, the absorption of the private saving by the Gov-
ernment has not yet taken it all, but it has absorbed a very substantial part, and
indeed, to the extent that is the case, we either have to borrow the funds from
abroad, or have equity investments from abroad to finance our capital invest-
ment.
And it is a combination of the amount of available saving and investment,
coupled with the productivity of capital — that is, the degree of technology's
capability of improving things in the context of what I was discussing with
Senator Bennett — that will determine how capital affects the rise in living
standards. But very obviously, if we have no private saving and we cannot
borrow it from abroad, unless we have such extraordinary technological capa-
bilities that we can create massive productive assets with very little invest-
ment, then clearly it would crimp the growth in standards of living very
measurably, and it is in that context in which I find the accelerated budget
deficit, which we are proceeding in toward the turn of the century, of very
considerable concern.
Senator Craig. One last question, Mr. Chairman. Congress and the new
Administration will soon embark on some kind of new budget agreement.
And let me ask this, in the context of what that agreement may or may not be,
how might markets respond, as you mentioned earlier.
If we do what we did in 1990 again, and by that I mean raise taxes substan-
tially and walk totally away from our spending reduction targets, as clearly I
think we did and as I think the general economy now reacts to, how can we
get the markets to believe that we are sincere, ^at we really will follow suit
when we have had well over a decade of saying one thing and doing abnost
another by two and a half times?
Mr. Greenspan. Senator, what the markets would probably respond favora-
bly to — ^and I hesitate to talk for such an abstraction as the markets — are ac-
tions, with respect to the federal budget, which are specific legislative
initiatives per lines in the budget, not goals or caps, not various different rules
by which certain parts of the budget will run, but very specific hard-wired
33
actions which affect the levels of expenditures and revenues in, say, five, six,
eight years from today.
Now, there is no question that the Congress could obviously reverse those
actions at a later date, and I don't deny it and I suspect market participants
wouldn't deny it. But most of it probably would not be reversed. And were
that the case, were we to, for example, recognize that we cannot accept this
accelerated growth in the budget deficit and put in legislative changes which
address those numbers in 1996, 1997, 1998, those types of actions would be
perceived as at least more credible than what we have seen to date.
Whether or not there is such a deep-seated degree of cynicism out there
that nobody believes anything, I am not sure, but my impression is that that
has not occurred. In other words, the evidence that President Clinton and his
associates are very seriously focused on — this long-term budget deficit — has
impacted in the marketplace, as we have seen in recent days.
And that would suggest to me that they are not cynical, that they really are
looking for real reasons to believe that the deficit will be brought down. And
should that be the case — as I have said many times before this and other
committees — long-term interest rates would fall, and that would create far
more short-term stimulus than most anything else we could contemplate.
Senator Craig. Well, thank you very much, Mr. Chairman. I hope the new
sax section recognizes your talents.
Thank you.
[The written opening statement of Senator Craig is on p. 58 of the Submis-
sions:]
Representative Obey. [Presiding,] Mr. Andrews, please proceed.
OPENING STATEMENT OF REPRESENTATIVE ANDREWS
Representative Andrews. Thank you, Mr. Chairman.
Good morning. Chairman Greenspan. It is nice to see you again. I would
like to ask you, just if you would, to follow your line of thinking in response
to the Senator's questions, and ask you to focus for a moment on tax policy.
Earlier this week Secretary Bentsen suggested some kind of energy tax. A
few days ago, the new Secretary of Labor suggested a $15 billion jobs pro-
gram. I wonder if you would give us your thoughts as we go about dealing
with the budget deficit, whether or not you think additional revenues will be
needed, and if so, what kind of caution would you suggest to the Senate Fi-
nance and the House Ways and Means Committee in going about that proc-
ess?
Mr. Greenspan. I would hesitate at this stage to get involved in the issue of
specific elements of whatever budget package the President is constructing.
He has a difficult time as it is to find the appropriate balance that will create
the type of improvements that he is looking for. And I don't think I can add
terribly much to that particular process.
The only thing I would suggest is that we have to recognize that one of the
major long-term problems at this stage is that the current services budget in-
crease in outlays in the out years, as the defense decline phases out and as the
savings and loan costs come down, now presumably increases at a rate faster
than the current services tax base.
34
And what that means is that unless you bring expenditures down, you have
to increase taxes every year. And obviously there is a limit to what one can
achieve in that regard, because there clearly are suppressing forces every time
we raise taxes.
So it is crucially important that we recognize that the elements involved in
bringing the budget deficit down in the longer term have to be on the expendi-
ture side, because they cannot be on the tax side because that it won't work. It
is an arithmetical economic problem.
Having said that, that is about as much as I can oifer, and how one achieves
the appropriate balance really gets to the problem of how one gets what into a
budget in which every line has a constituency who wants it there.
Representative Andrews. Well, one of the things you suggested to the
Ways and Means Committee last year was that we needed to be playing a
long ball here, encouraging long-term savings. I assume you still feel that
way, and would suggest that the Congress move in that direction if, in fact,
there is some kind of revenue bill.
If there was a revenue bill, and there certainly appears that there will likely
be one this year, do you think it is im|3ortant that there be incentives built into
that bill — investment tax credit, for example?
Mr. Greenspan. I don't want to get specifically into any of the individual
revenue areas. As you know, I have testified before Ways and Means on the
desirability of indexing the capital gains tax, both retrospectively as well as
forward, because I do think that in the context of the difficulties that small
businesses are having and the employment problems that are so obvious,
when one looks at these charts, that is another way of saying that small busi-
ness employment is subnormal. Anything we can do to encourage incentives
which will create new businesses and new ideas, especially in the context of
my colloquy with Senator Bennett is important. We need to encourage enter-
prise, and in the context of the tax code, it strikes me that is the thing that is
missing most at tPiis point.
Representative Andrews. Thank you.
Thank you, Mr. Chairman.
Representative Obey. Senator Dorgan, please proceed.
OPENING STATEMENT OF SENATOR DORGAN
Senator Dorgan. Mr. Chairman, thank you very much. And let me indi-
cate how pleased I am to be with you on this Committee and serve with you
again, working on economic issues.
Chairman Greenspan, welcome. I would like to ask you a couple of ques-
tions about measurements.
You are an economist and you undoubtedly are flanked by economists be-
hind you, and you work with economists all day and all week and all month
and all year, and when you speak to us and to the country, you speak based on
your evaluation of measurements. Some of your economists could almost do
it from a bunker, I expect. You take a look at the sheets, see what the numbers
show, see where the numbers move, and give us an analysis of what that
means for our people and for the country.
35
I have been wondering for some time whether these measurements really
work at all and whether they are really very useful. I wonder if what you
measure might not be the equivalent of trying to fly a stealth bomber with the
dials and gauges of a gas stove. If you see that, ri^t out this window, there is
a car accident, you say that accident is going to represent economic growth
because there is going to be repair, a lawyer litigating, a hospital bill.
The reason I am asking you these questions is, I sat on the Ways and
Means Committee throughout the 1980s in which we had seven years of
broad national economic growth reports, and now we look back at the 1980s
and see that what was economic growth represented a sickness that, in my
judgment, has caused serious problems for this countr> in the late 1980s and
the 1990s.
For example, we end up as taxpayers owning junk bonds in the Taj Mahal.
An interesting sort of hood ornament for the failure of the 1980s, all of the
speculation, all the debt financed transactions, most of which created no new
wealth, most of it represented by numbers which said, "This is good, this is
growth, this is movement."
I am asking you if, now having had this experience of hostile takeovers
and junk bonds and an incredible orgy of greed, including things I have asked
you about, highly leveraged transactions, whether we ought not now take a
look at whether tiiese measurements represent what is real to people in small
towns across the country about whether or not we are progressing and mov-
ing ahead and growing.
Mr. Greenspan. Well, Senator, I would like to indicate that, perhaps to
your surprise, we economists do think about that issue, and try to differentiate
the types of growth or types of economic output which really directly benefit
people, those of which are insurance, such as defense expenditures; those of
which are repair or health expenditures. You even get the problem where the
difference between the climates is relevant, because those areas of the country
which don't have major fluctuations in temperature neither consume fuel nor
air conditioning in very great amounts, and obviously that is not produced. If
you produce it, it looks as though it is real GDP, but it doesn't help anybody in
those regions.
It is a very tricky and very interesting question you raise, because we do
think about that, and it is very important to recognize, from a so-called wel-
fare point of view, what elements of economic output and how they are dis-
tributed actually create rising standards of living directly, and those which are
peripheral to that phenomenon.
Senator Dorgan. But during the 1980s, I was in several hearings where I
had the opportunity' to question you. I was never able to determine whether
you made any qualitative judgments about the difference in activities of
someone who was creating a junk bond in order to allow a takeover minnow
to go after an economic whale someplace, that created no advance and no
economic activity and nothing but ruined jobs and dashed hopes, versus the
borrowing of some money to buy a truck to haul some grain.
I was never able to determine if there was any qualitative evaluation by
economists, or by the Fed, that one was better for the country' than the other.
Am I wrong about that?
36
Mr. Greenspan. Partially. You have to distinguish between how we as indi-
viduals and citizens make those value judgments and how we in effect do our
jobs. The particular issues that you are raising are largely questions of regula-
tion and tax incentives which are crucial to how government affects the struc-
ture and activity. And that clearly is congressional initiatives as distinct from
monetary policy.
We have to, of necessity, take that structure as given and try to function
with the value system implicit in it that is given to us by the Congress.
Senator Dorgan. And I accept and understand that. One of the reasons I
was asking this question is because we have been looking at this issue of for-
eign corporations doing business in this country and failing to pay taxes.
Let me give you an example of one evaluation of that. One case is a com-
pany in Singapore, doing business with a company in this country and trans-
fer pricing 5ie profits. One case lasts 10 years and fills 19 file boxes fiill of
data and depositions and litigation papers, and so on.
All of that I will bet is counted in our national accounts as growth. I would
bet on it. Don't you think it is? It is lawyers, accountants, airplane trips, all of
this, 10 years' worth of nothing is represented in our accounts as an advance-
ment In fact, it is a sort of national sickness because we are not moving ahead
to do what we need to do to create jobs and advance the standard of living for
people who live in our towns. And that is why I am asking, I wonder if we are
measuring the right thing.
Mr. Greenspan. Senator, I think we are measuring the right thing. It is im-
portant, however, to interpret it correctly. And, depending on what it is you
are trying to make a judgment about, the data we collect would enable us to
make the types of judgments or correct the data as you would like to do de-
pending on what you include.
For example, this came up in one very interesting way very early on when
economists were trying to decide what should be included in the Gross Na-
tional Product. Should the output implicitly of housewives be included? And
that was a very important debate, because it is very obvious that there is activ-
ity that creates wealth in that process.
If we are going to put the imputed value of homes in the GNP, why not the
imputed value of the services of housewives?
This issue has gone on for generations now, trying to define what is the ap-
propriate measure of the Gross National Product which best reflects the wel-
fare of the society.
Senator Dorgan. And we wont solve that today, but again I point out, if
you are not in public office in Washington and are instead raising chickens,
and I am not in public office, I am raising com, and you and I simply ex-
change chickens for com and we both are fairly happy about that exchange,
my guess is that the car accident outside this building has a bigger impact on
the measure of economic health in this country than tihe chicken and com you
and I raised for each other's consumption, at least in the cmrent method by
which you measure national progress.
It is a point that I hope you and I can talk about, because the issue today is,
what is going to happen to this country in the fUture, what kind of growth
rate? And you talk about the measurements of money and targets and so on,
37
could you just for the purposes of someone in my hometown this morning
who might be listening or watching the Chairman of the Fed, could you syn-
thesize your analysis just in terms of your broad judgments about what we
might see in the next 1 8 months?
We are told by some that we have long-term anemic growth ahead of us.
We are told by others, gee, things are going to be better than most of us ex-
pect. How would you summarize what our prospects are for the next 18
months, or the short-term immediate term?
Mr. Greenspan. Senator, I have eschewed doing that so far today, and I am
not going to do it largely because I am planning to go before both the Senate
Banking and the House Banking Committees, delivering precisely those fore-
casts in a very few weeks, and I would just as soon not give you my impres-
sions, even though I don't know what the governors and the presidents of the
banks at this stage have put down on their reports that are in the process of be-
ing collected.
Senator Dorgan. Are you generally optimistic or depressed?
Mr. Greenspan. I tried to capture my view in my prepared remarks. We are
making progress, but as I tried to describe it, whereas a year or so ago, I
looked at the problems we were confronting in trying to adjust the debts that
we had as trying to make progress against the 50-mile-an-hour head wind, the
head wind is less now, but it is not zero.
We are not yet out of the woods of the various types of problems that we
have been confronted with in recent years. There is no question that we have
made very substantial progress.
The American banking system, which a little more than two years ago was
in rather dubious shape, has improved very substantially. The instability in the
financial system elsewhere, which we were greatly concemed about, has very
dramatically become subdued. And a number of the problems which we
feared might happen didn't.
And that is, in a sense, a measure of things getting better, but I wish to be
very clear that I don't think we are there yet. We still have a ways to go.
Senator Dorgan. Mr. Chairman, thank you for your indulgence. I would
like to ask one additional question in closing, if I might.
One of the things I have been thinking about in this issue of growth, all of
us are chasing these twin goals, stability prices and growth. In tiie 1980s, we
had years of economic growth. At least tiiat was what we would read in the
newspapers.
In my state of North Dakota, we didnt fare quite so well. So even if we
reach the target of national economic growth and we say, all right, we are
clearly out of a recession, clearly on the mend, the growth is now not dubbed
as moderate but probably robust, even at that point we may find ourselves in a
place where some of us in Congress are representing regions of the country
where there is not growth but recession.
In North Dakota, as an example, my home county lost 20 percent of its
population at a time when the newspapers were talking about all this wonder-
ftil growth. We need to think regionally as well as nationally, to try to under-
stand what is going to happen to the Northern Great Plains region, what can
38
we do to respond to some of those needs, particularly in the area of credit and
other areas.
And I would hope to have a dialogue with you in the months ahead about
how we can take a look at both the combination of monetary and fiscal poli-
cies, to care not just about the national aggregate — ^aggregate growth is im-
portant for a lot of reasons — but what is happening in some regions of the
country that have suffered, in some areas in the country that have suffered, an
increasing gap in income between urban and rural areas.
You know, for a couple of decades we were moving in the right direction.
In the 1980s, there is now an increasing gap between rural and urban areas,
and of course the state I represent is largely rural.
So I hope we can be discussing that, because I think that is also a very im-
portant element of answering the question, is this country recovering, or is it
just the West Coast, the East Coast, and the South?
Mr. Greenspan. I very much agree with that. Senator.
Senator Dorgan. I hope we can spend some time working with the Fed on
that. I will raise those questions repeatedly in the Congress, as well.
Thank you very much.
Representative Obey. Dr. Greenspan, we are going to be running into time
problems so I am not going to be able to stay here very long, but let me sim-
ply make a summary observation, and then shift gears and ask you a couple of
questions on a very different subject before we wrap this up.
Can you recall any period in modem history when inflation rose and unem-
ployment was at 7 percent or more?
Mr. Greenspan. I am sure that if we looked at other countries similar to
ours
Representative Obey. In this country, I am saying.
Mr. Greenspan. In this country, I don't recall a specific period. I would be
very doubtfiil.
Representative Obey. I don't think you will find one.
Mr. Greenspan. But let me put it to you this way, Mr. Chairman. It is tech-
nically feasible as indeed a number other countries have exhibited to us.
Representative Obey. I understand, but I think any rational person is going
to be assessing the degree of risk, and I think we would say that with unem-
ployment at these levels, the risk of inflation becoming a significant problem
is minuscule if existent.
Mr. Greenspan. If you are asking me, do I think the inflation rate is likely
to accelerate any time soon, the answer to that is, as I will stipulate, probably
not. But I do think that it is important to be very clear that the issue is not
short-term inflation solely. It is also the very important expectations of infla-
tion in not one or two years from now, but four or five, six, ten years out. And
that concern on the part of the marketplace has elevated long-term interest
rates to a point where they are significantly above where they have been in
previous periods of very low inflation.
So I would suggest to you that while it is certainly the case that there is no
evident short-term inflation concerns, the markets have created a structure of
39
interest rates which indicates that that concern exists out there, and that is
probably suppressing economic growth now.
Representative Obey. Well, let me say, I have concern that is a mirror im-
age of that. I don't really want to see a major economic stimulus package right
now. I am more concerned with seeing us begin, right now, making the right
investments in both the private and public sectors to assure long-term growth.
But when you have public opinion which indicates that two thirds of the
American public still believes we are either in a recession or a depression, if
the policy of govemment is not seen to be sufficiently responsive to those re-
alities, which, in my view, are much larger than the potential of significant in-
flation growth any time soon, then I think you are going to see the release of a
tremendous amount of political pressure to, in fact, have the kind of rapidly
expansionary stimulus package that I don't think you want.
I also don't believe that developments — ^and I don't think you do — in Japan
or Germany — the other two crucial engines of world economic growth? — I
don't think that what is happening in those countries is indicating any signifi-
cant help in expanding the economy worldwide.
And I think that the problem we have is that the slow growth with which
we have been plagued, and the slow degree to which we have come out of
this recession, in fact, also helps suppress wage growth, and that in turn cre-
ates more long-term problems for this country.
I frankly believe that the chance of inflation becoming a more important
threat to the economic well-being of this country than weak economic growth
for the foreseeable future is about as great as the New England Patriots'
chance of winning the Super Bowl next year. It just aint going to happen.
And I really believe it is essential that not only the President properly cali-
brate his response to this very troubling situation that we are in, but I also
think it is terribly important that you neither follow nor be perceived to be fol-
lowing a policy which leaves insufficient room for economic growth. Be-
cause in the last analysis, in addition to the problem of growth, we are dealing
with two deficits. We are dealing with a budget deficit; we are dealing with
an investment deficit.
You can better summarize than I can the drag which is created in the econ-
omy because of insufficient private investment. I know that you are con-
cerned about that.
But that is mirrored on the public side as well. You cant see the chart fi-om
there, but the fact is that if you take a look at the federal budget and the invest-
ment portion of the budget — ^and I am not talking about the bleeding heart
consumption items, I am talking about hard-nosed investment, investment in
kids by way of education, investment in infi"astructure that makes communi-
ties more efficient places to function, about investment in science research,
programs like that — as a percentage of our federal budget, that investment
portion has dropped from 16.5 percent of the federal budget in 1980 to less
than 9 percent today.
And it is important if we are going to achieve the kind of sustainable
growth that you are talking about. It is important in my view that we make
tfie right kind of private and public investments at the very same time we are
dealing responsibly with the deficit. And if we don't attack all three problems
40
and focus only on one, we are going to strike out a lot. And that is not going
to help anybody.
I think your role is key. And despite all the assurances or concerns ex-
pressed here this morning, the proof will be in the actions of the Fed. So we
will simply have to watch and review what happens.
I would like to switch to a different subject, if I can, for just a moment, be-
cause I wear a number of hats around this place, and one of them is as a mem-
ber of the Appropriations Committee. This is an area in which there is a
renewed interest in accountability. And I know the answers to these ques-
tions, but I think it would be useful simply for the benefit of the public record,
once again, to have you state them.
How much did the Federal Reserve System spend in 1992 to conduct its
operations? For the total system? Was it about $1 .7 billion?
Mr. Greenspan. That is the right order of magnitude, yes. The operating
expenses are $1 .4 billion.
Representative Obey. Would you describe for the record how you get $1 .4
billion as opposed to $1 .7 billion? I would appreciate that. But let me ask you
a question.
Mr. Greenspan. I am sorry. What I was giving you is the budget of the 12
Reserve Banks. Part of the difference, not all of it, is Board expenses, which
were $129 million, and the cost of the currency of $295 million. Remember, a
goodly part of the operating costs are met by receipts that we get from the pri-
vate sector for the services that we engender. But I think that reconciles the
$1.7 billion.
Representative Obey. Would you explain, again, for purposes of the public
record, how you finance your operations? Where do you get your money?
Mr. Greenspan. Basically the monies that we get are created for the Sys-
tem, as a whole, through the investment in securities by the Federal Reserve
Banks, which engenders a significant amount of income, the vast proportion
of which, of course, goes directly to the Treasury. The remainder constitutes
our operating expense; or more exactly, we budget our operating expenses for
the System, as a whole, and with the exclusion of the dividends that are being
paid by statute, the remainder of those funds go as direct payments to the
Treasury Department and appear in the budget item under the receipt seg-
ment.
Representative Obey. So the point that needs to be made clear here is the
fact that you do not receive your money through an appropriation from the
Congress?
Mr. Greenspan. That is correct.
Representative Obey. And the Congress does not in fact pass on your
budget, nor does the President.
Mr. Greenspan. We do report to the Congress on our budget, and indeed
we testify on it before a Subcommittee of the Banking Committee.
Representative Obey. But there is no action required by the Congress or
the President in order for you to receive your operating expenses?
Mr. Greenspan. We do not use appropriated funds.
Representative Obey. Why shouldn't the Federal Reserve have to receive
its budget through the normal process, just like any other government agency?
41
Mr. Greenspan. This goes back a long way, and really relates to the issue
of the nature of the degree of independence of the Central Bank in this coun-
try. And it was judged early on that it would be appropriate for us to function
in the way in which we do but be accountable
Representative Obey. When was that initial decision made?
Mr. Greenspan. The decision was made implicitly in the Federal Reserve
Act of 1913, in the sense that the Federal Reserve Banks themselves began to
engender income by making discounts and eventually purchasing securities,
and the creation of the Federal Reserve Board being financed from part of
that goes back to the earliest days of the institution.
Representative Obey. As you indicated and as several members of the
Committee indicated this morning, things have changed considerably since
then. I understand the argument that is made that you ought to be able to draw
on your own funds without having them approved by taxpayers' representa-
tives because you want to remain independent. But I would suggest that I
think times really have changed.
I am not at all convinced that in this age of modem communications
— much fuller accountability — that that argument would hold much water
with the people with whom I represent or anybody else represents on this
Committee. And I would submit that you have a whole lot more to do and a
whole lot more effect on the welfare of my constituents than in fact I do.
I would trade powers with you any time. And it just seems to me that
President Bush didnt exactly refuse to demonstrate his independence vis-a-
vis the Congress. He did that on a regular basis, despite the fact that we re-
viewed his budget. We had competition between branches, but at least we had
the forum if not the reality of accountability on budgeting.
And I am really not persuaded that the time has not come to establish that
kind of accountability with respect to the Fed.
Mr. Greenspan. Well, Mr. Chairman, it is fairly clear that we at the Fed-
eral Reserve Board and the Reserve Bank presidents are acutely aware of our
responsibility to keep our expenses down. And we go through a very rigorous
procedure to make certain that we run a very efficient shop. And I think the
record over the years has indicated that we have been quite successful.
We at the Board, for example, spend a considerable amount of time mak-
ing certain that the Federal Reserve Bank budgets are kept in check and that
we audit what they do and make certain that there are no inappropriate activi-
ties which are being created.
Representative Obey. I didn't mean to suggest they are not, in any way. I
didn't mean to suggest that. I am just questioning whether or not this institu-
tional arrangement, which may have served the country fine in an era when
virtually every other institution of government was closed. I mean, the Appro-
priations Committee used to hold its public hearings in private. You couldn't
get your staff in, let alone let a poor member of the public in. We have had to
change our processes, and I am really wondering whether the time
Mr. Greenspan. Let me tell you what function it serves, and it is the judg-
ment of the Congress to determine whether that is what you want.
It is fairly apparent that were we to be involved with an appropriations
process, then clearly the ability to affect monetary policy can be engendered
42
through that process, because he who controls the particular budget and con-
trols who does what can run the organization. The Congress can choose to
run the Federal Reserve if we are subjected to very detailed scrutiny and
authorizations in our budgets.
Now, that may not be the purpose of what you would do, but it is clearly
what would occur. And this is a judgment which the Congress has made over
the years in its constitutional auAorities with respect to monetary policy, with
which we fully concur.
And my judgment is that the difficulty of having a Central Bank with a mo-
nopoly over the issuance of the currency in a democratic society is a very dif-
ficult balancing act to initiate.
My own judgment is that we have a society and an economy in which indi-
viduals make their choices on a day-by-day basis to save and invest and con-
sume, and they construct an economy which has essentially long-term assets
associated with it.
We build buildings to last a long time. We build organizations that have a
long-time frame. And it is very important that the Central Bank be an institu-
tion which supports the stability of the financial system over the longer term.
I think this is the reason Congress chose to give the governors 14-year
terms, and why it is that you have chosen to create essentially a significant de-
gree of independence in the institution which has served us exceptionally
well, and I would be, as a citizen, most concerned if that were abridged.
And I am fearful that a significant retrenchment in the independence of the
institution, which could occur for a number of reasons, would not serve the
American people better in any material way that I am aware of
Representative Obey. Let me make the point that you indicate that you
deal with institutions that build assets. That is true, but I would suggest that
the institutions are building assets for a small number of people. There are an
awful lot of people in this country who have virtually no assets. And I think
that they often feel that government is being managed on behalf of the folks
who do to a much greater extent than it is for the folks who don't.
Mr. Greenspan. I wasn't referring to assets in the context of who owns
what.
Representative Obey. I know you weren't, but I was using the word in a
different way to drive home a different point.
Mr. Greenspan. I am referring to the issue of investment in the structure of
our economy, which has created for the average American the highest stan-
dard of living that has ever existed. Those are tiie assets which do it, the tools
that we have been able to create and build over the generations that have cre-
ated our standard of living.
Representative Obey. But, for example, a decision on your part to come
down on the side of protecting those who do have financial assets by being
more concerned with the inflation rate rather than coming down more on the
side of those who have very few assets, especially those who have faced eco-
nomic hardship and face dwindling assets because of their being unemployed,
I think that creates some very unhealthy populist — in the worst sense of that
word — tendencies in this country.
43
Mr. Greenspan. I would agree with you if that, in fact, was what we were
doing. Our basic view essentially is to support the total system, and it is not
appropriate for a Central Bank to come down on one side or the other in this
particular issue. I think that what
Representative Obey. But your policy judgments do.
Mr. Greenspan. Policy judgments do, but the Central Bank should not, and
we do not.
The issue is essentially the recognition on our part that the overall economy
in which every individual in our society contributes and benefits requires a
stable financial system. If we cannot provide that, then the economic system
would be in serious difficulty. Our view is essentially that we are supportive
of the economy and therefore the society as a whole, and it would be most in-
appropriate for us to craft our policies to try to focus on the benefits of any
particular segment within that society.
Representative Obey. But, in fact, your policies do just that. Our policies
do just that. We may not describe them that way, but in fact those policy deci-
sions determine who will have more and who will have fewer assets in this
country. We do it every day.
Mr. Greenspan. I agree that whatever we do obviously has secondary and
tertiary effects. But that is not our primary purpose. On the basis of certain
things that we do, whose primary purpose is financial and economic stability,
there is nothing that we can do to prevent the secondary and tertiary effects
which may or may not be socially appropriate fi-om the point of view of val-
ues held by the Congress or particular segments of the Congress.
And I suggest that that is one of the reasons why we have a very significant
amount of legislation which tends to address those questions. I just
Representative Obey. This debate itself demonstrates that there are some
very high stakes involved. And I really do think it is inappropriate to continue
the absolute total budgetary unaccountability of perhaps the most powerful
economic actor in the countiy. Let me ask you a different question.
What would be wrong with having the Secretary of Treasury and the heads
of 0MB and the Council on Economic Advisers, what would be wrong with
having the law require them to sit down with the entire Open Market Com-
mittee three or four times a year?
Mr, Greenspan. I don't see why you need it as a law. If the Secretary of
Treasury asks me, if he said he would like to have dinner with the Federal
Open Market Committee on such and such a date, I would be delighted to set
it up.
Representative Obey. Let me just say, I come from a small town area. I
don't have a city in my district larger than 35,000 people. In the culture of
communities like that, if you tell them there is no regularized process by
which the managers of one branch of government get together and deal di-
rectly with the most basic economic issues facing this country, and that those
decisions are done only informally and over dinner, they would tell me I was
nuts. They would say that the system was nuts.
I am looking for a way without interfering with your legitimate needs to be
independent intellectually and substantively, I am still looking for a way to
make certain that the system itself is sending the right messages that the
44
Congress expects the Executive Branch and the Federal Reserve to be coop-
erative to a very intimate degree.
Mr. Greenspan. I understand your concern, Mr. Chairman.
Representative Obey. What I am leading up to is, what is wrong with
something like the Hamilton bill? Senator Sarbanes, Congressman Hamilton
and I have all sponsored versions of that legislation in the past, but this is the
first Congress in which you are going to see that dealt with seriously.
Mr. Greenspan. Let me first state with respect to the Senator's bill, which
he has pursued in a very straightforward and conceptual manner, that if the
Congress were to pass that bill, it is very apparent that I and my colleagues at
the Federal Reserve Board would have a very significant increase in power.
And I say that as prelude to the fact that none of us are supportive of the Sena-
tor's initiative. And the question you have to ask us is, why?
Now, in this town that is a very unusual phenomenon. And the basic reason
is that — ^and I assume I will have the opportunity to discuss it at the appropri-
ate hearings that you will set up — it is our view that the system would change
in a manner in which the capabilities of the Central Bank to do what Central
Banks have to do, and which I think we do well, would be eroded. And I dont
think that would serve the interests of the American people.
Representative Obey. By having to regularly and oflTicially discuss eco-
nomic matters with
Mr. Greenspan. No, it is not that part I was referring to. I was referring to
the issue of removing the presidents from the Federal Open Market Commit-
tee, which is a crucial change in the structure of our institution.
Senator Sarbanes. What is the public legitimacy that those presidents now
have? They are selected by private interests, are they not?
Mr. Greenspan. They are selected by a board of directors of the individual
banks with essentially the consent of the Federal Reserve Board.
Senator Sarbanes. The board never withholds that. Six of the nine direc-
tors are elected by the banks, isn't that correct?
Mr. Greenspan. That is correct.
Senator Sarbanes. And then they pick the president. Some of the presi-
dents, on a rotating basis, go on the OJDen Market Committee and make very
important public policy decisions, but they have no public legitimacy.
I may disagree with a decision that you and the members of the Federal Re-
serve Board may make, but I concede your public legitimacy. You were
nominated by the President and the elected Executive Branch with political
authority and confirmed by the Senate. You have, in effect, passed through a
public screening in order to occupy that position.
There is no Central Bank in the world, in the advanced countries, at least,
that I know about, that puts people on their Boards who are selected by pri-
vate interests, even the Bundesbank, so reputed for its independent status.
They are selected by the upper branch of tiie German parliament. They go
through a public process that places public legitimacy.
We are getting the presidents of the Federal Reserve Banks by having them
picked by other bankers. I can understand that, but they are selected by pri-
vate interests and make very important public decisions. That is the essential
rationale for that particular measure.
45
It is true that that would enhance the power of the Board of Governors, be-
cause you would then make the decisions made by the Open Market Commit-
tee. You might make decisions that I would strongly disagree with on the
substance, but at least I grant the fact that you have been through a public
screening that puts you in a position to make those decisions.
Mr. Greenspan. Senator, I would say, the basic concerns that we have,
were we to reduce the authorities of the presidents of the Reserve Banks, is
that it would eventually attract far less capable people, because obviously the
role that they have in the Federal Open Market Committee is what crucially
attracts them to the job, and we get extraordinarily good people as a conse-
quence. It is
Senator Sarbanes. How much do those bank presidents make?
Mr. Greenspan. It varies. Don't hold me to the specific numbers, but I think
the range is from $ 1 50,000 to $250,000 a year.
Senator Sarbanes. To a quarter of a million dollars a year?
Mr. Greenspan. Yes. I would argue that every one of those people would
make multiples of that in the private sector.
Senator Sarbanes. Some of them are fairly young when they get the job.
They go to the private sector and get multiples, don't they?
Mr. Greenspan. It works both ways, I think.
Senator Sarbanes. It certainly does, but they get that benefit as well.
Mr. Greenspan. I don't think that is the reason they are able to do that.
Senator Sarbanes. They have no public legitimacy. The alternative would
be to require their nomination and confirmation. That is another route that
one might take. That would give them public legitimacy if you require that
the Reserve Banks' presidents be nominated by the President of the United
States and confirmed by the United States Senate, that is an alternative way to
doit.
Mr. Greenspan. If you do that, you run into another very difficult problem.
At the moment. Chairman Gonzalez' bill, which as you know advocates that,
retains the power of the Board of Governors to dismiss any president, and in-
deed it is that power which enables the Board of Governors to essentially run
the System.
If that occurs, then you have the dubious constitutional situation in which
the President of the United States nominates and the Senate acquiesces to an
individual who is then fired by the Board of Governors of the Federal Re-
serve System. And the problem that that creates is obviously intolerable, but
the issue of removing that particular capability from the Board of Govemors
would make the ability of tiie Board to run the System, which is our statutory
purpose, virtually impossible, because under those conditions
Senator Sarbanes. That is not the approach I have taken. Mr. Chairman, I
don't want to divert over on this issue, but if I could add one other line of
questioning. When Professor Samuelson came before the Committee on De-
cember 30, he said:
My probability estimates are that it [meaning the Federal Reserve] will let
market interest rates tighten when and if the economy gains growth and
momentum. For my sins, I deal with active money maiket traders all the
time, and their explanation for the veiy steep Treasury yield curve, in
46
otiier words, this contrast between short-term rates and long-term rates, is
precisely their confident expectation that this is what the Fed is going to
do. And I may say the Fed is right on target in its ever>' statement, to wit
the discussion of how the M2 targets shoiild be changed.
Later, I asked Professor Samuelson the following:
I want to be clear on one point with respect to this steep yield curve. As I
understood your testimony earlier, making reference to the money traders
with whom you have been in contact, the high rates on long-term securi-
ties, as you understand it fi-om them, is attributable at least in part to their
expectation that the Fed will tighten monetar>' policy in order to combat
some inflation that they might see coming, or sort of conjure up as com-
ing, as you begin to get a recovery. And therefore, given that position of
the Fed, the long-term securities are staying at a higher rate. Is that cor-
rect?
Professor Samuelson answered:
Yes, and it is incorrect in my experience that these smart people in the
money markets see bottlenecks in the production process which is going
to raise prices as soon as output rises, or see a resurgence of militant un-
ion wage activity. That is the explanation usually given.
Now, I think this is a very interesting point. In effect, I think it asserts that
the Fed, by sending these hypersensitive signals about tightening monetary
policy, is leading people to engage in a behavior that anticipates that policy,
and therefore explains in part this steep yield curve.
We have a time now that by any rational judgment, the apprehension about
inflation should be less now than at other times in our past. And yet the yield
curve is, I take it, at the steepest it has ever been. I mean, you could only
square this rationally if you could argue that the apprehension of inflation was
the worst it has ever been — and that is clearly not the case — going back
through the postwar period. You have had other periods of time when the ap-
prehension of inflation was reasonably much greater than it is now, and the
yield curve was not as steep.
It seems to me that lends credence to the point made that maybe a contrib-
uting factor to the steepness of the yield curve is a perception that the Fed is
going to embark on this tightening policy and the interest rates are going to go
up again.
Now, you know, the Fed's attitude and approach may be contributing to the
very problem which the Fed asserts it doesnt want to see happen. In fact, I
asked Mr. Hoskins the following question — ^your former Open Market Com-
mittee member out in Cleveland:
Would you say it is accurate for a trader to look at tiie situation and
calculated to himself, "Well, I just went home last night and I read the
Federal Reserve Board and Federal Open Maricet release on the record of
policy actions taken by the Federal 0]3en Maricet Committee at its meet-
ing on November 1 7, 1 992, and the way I read that [this is a hypothetical
trader talking] is that I think they are going to start taking these rates back
up again, and that is what I think is going to happen. So I am going to
play the game that way, I am going to expect these rates to go back up."
Is that an irrational calculation on their part?
Mr. Hoskins answered:
No, it is not I cannot discount that as a possibility.
47
Now. what about that? I was very struck by that observation by Professor
Samuelson, and when you start thinking about it, it seems to me to have con-
siderable credibilit\\ If there was a real basis for an apprehension about infla-
tion, you might have a different situation, but as I pointed out earlier you have
the best inflation record in 25 years.
But what the Fed is saying is, look, as soon as we get a little bit of growth
moving here, we are liable to take these rates right back up. So they sit there
and calculate, these rates are going to go right back up. We are not going to
bring these long-term rates down because we will be locked into that long-
term situation. The Fed, as soon as they get any basis on which to take the
rates back up, that is what they are going to do. There we are. It is a Catch 22.
Mr. Greenspan. May I comment. Senator?
Senator Sarbanes. Certainly.
Mr. Greenspan. Thank you.
I have several problems with Professor Samuelson's notion. The first obvi-
ous one is that at the tail end of the yield curve is a 30-year bond. Our terms
are 14 years, so he is obviously referring to some FOMC, quite distant from
any of those who serve on it at this particular point.
Senator Sarbanes. Are not the bonds, their value is heavily weighted to the
front-end, even the long-term bonds? Is not that correct?
Mr. Greenspan. That is correct. Let me come to grips with that issue. It is
only partly the case.
The best explanation that one can have about why this yield curve exists is
not that there is an inflation expectation about the short run. As I indicated in
answer to an earlier question, the general judgment of the marketplace is that
inflation in the next year or two is likely to be quite subdued, which raises the
question, why then are the yields of 5-year, 7-year, 12-year, 20-year bonds so
significantly elevated, and by any reasonable calculation have a significant in-
flation expectation in them?
Because, for example, a 10-year bond has an inflation premium built into it
which is the average expected inflation over the fliU maturit>' of the debt in-
strument, that is 1 0 years. And what one must necessarily infer from that, in
my jud^ent, is that while the markets do not factor in very much in the way
of inflation expectations in the short run, they believe that this particular pe-
riod, which we are currently going through, is an aberration, and their belief is
that on the basis of aggregate policy, most specifically fiscal policy, at some
point down the road, inflation will reemerge, and they have embodied that in
the marketplace.
Senator Sarbanes. Let me put an alternative hypothesis to you. I am sitting
in one of these luxurious boardrooms up there on Wall Street and I say, I don^
think we are really going to have a problem with inflation, but Greenspan and
his gang at the Fed, as soon as we get a little bit of growth, they are going to
start raising the interest rates. They will say. Why are they going to raise the
interest rates if there is not going to be an inflation problem? They are so hy-
persensitive to this issue, they are simply going to jump like a cat at any sign;
they are going to jump even if there is no sign.
48
You had a meeting in November talking about tightening the interest rate.
We are getting the best figures on prices both around and subsequent to that
meeting than we have gotten in 25 years.
So I say, there is not going to be an inflation problem. But regardless, my
calculation is that this outfit at the Fed is going to take interest rates back up
again and I am going to operate off of that premise. What is irrational about
that?
Mr. Greenspan. To answer
Senator Sarbanes. The only irrationality would be if you are not going to
do it. Are you not going to do it?
Mr. Greenspan. Senator, I am not going to answer monetary policy ques-
tions now, as you well know, and I regret that I can't get into this dialogue, but
I must say I would like to, but I can't.
Senator Sarbanes. Thank you very much, Mr. Chairman.
Representative Obey. Mr. Greenspan, we are out of time. Thank you very
much for coming. We appreciate it.
[Whereupon, at 1 :05 p.m., the Committee adjourned, subject to the call of
the Chair.]
49
SUBMISSIONS FOR THE RECORD
WRITTEN OPENING STATEMENT OF REPRESENTATIVE ARMEY
As a matter of record, I am here today to note that no House members have yet been ap-
pointed to the Joint Economic Committee, nor has an organizational meeting of the Committee
yet occurred. In other words, the JEC has no house members, and it is simply inappropriate for
the committee to be conducting business. This is yet another example of how much respect the
Democrats pa\' to the rules of the house. We should wait for our house members to be named be-
fore holding rump hearings.
This aside, I hope you would address the issue of Federal Reserve accountability this morn-
ing. Chaiiman Greenspan. The relationship of the Federal Reserve to the Congress has been the
subject of much discussion and legislation in the last few years. A number of bills have been in-
troduced with the effect if not the intent, of increasing congressional influence over Federal Re-
serve polic>Tnaking. The record suggests that this would be a great mistake.
Whatever may be said about imperfections in Fed polic>'. there is every reason to believe that
congressional meddling would only make the situation much worse. After all. Congress has es-
tablished a track record in exerting influence in the financial sector, and we know that this influ-
ence was often exerted in improper ways. Congress helped to create the half a trillion dollar S&L
disaster that we are still cleaning up after. Prudence suggests that we should finish undoing this
damage before la>'ing the groundwork for a new debacle in the financial services indusCry.
It is increasingly clear that the task of implementing a coherent economic policy is going to
be left to the Federal Reserve in coming }ears. Mr. Clinton, after falsely condemning the Repub-
licans for raising the taxes on the middle class, now is proposing to do exactly that despite his
promises to cut their taxes.
Nonetheless, during the campaign Mr. Clinton stated his view that Federal Reserve policy
had been about right In light of his statement, why all the recent Democrat Fed bashing? It
would apjxar that the Democrats have so little confidence in the ever changing economic policy
of this Administration that the Federal Reserve is needed as a scapegoat As the economy is bur-
ied in new taxes on the middle class and onerous regulations, a convenient whipping boy will be
required. Chairman Greenspan, I don't envy your new role in our government
50
WRITTEN OPENING STATEMENT OF SENATOR SARBANES
I am very pleased to join with Congressman David Obey in welcoming the Chaimian of the
Board of Governors of the Federal Reserve System, Alan Greenspan.
Last year was not a good year for American workers and their families. It started with unem-
ployment at 7.1 percent, it ended with unemployment at 7.3 percent and unemployment stayed
above 7 percent all year. The average number of people unemployed each month was 9.4 million,
which means that 23 million people or more were jobless at least once sometime during the year.
In addition, there were more than 1 million people who were so discouraged by the lack of jobs
that they simply gave up looking for wortc, plus 6 million who worked at part-time jobs because
there were no flill-time jobs available.
According to the National Bureau of Economic Research, the economy has been in a techni-
cal "recovery" since March of 1991. GDP is rising, but only one-third the rate of previous recov-
eries, and that is too slow to create jobs. The unemployment rate for December was five-tenths of
a percentage point higher than at the recession trou^ in March, 1991. While economists may
call this a recoveiy, to the worker it is still a "jobs recession".
The principal economic task facing the country now is to achieve a rate of growth fest
enough to make real and substantial progress on the jobs front To achieve this, we will need eco-
nomic policies which focus on strengthening the pace of recovery.
I have become very concerned recently that monetary policy may not be adequately suppor-
tive of recovery in the labor market At the last meeting of the Federal Open Maricet Committee,
members of that Committee indicated considerable support for a lower target for money supply
growth in 1993:
During the discussion, the members generally agreed that developments since mid- 1992 had
reinforced the case for some reduction in the 1993 range for M2, and they indicated that they
probably would support proposals for a lower range.
Lowering the target for money growth implies that the Fed is content with the anemic rate of
growth that we have had so far in this recovery.
I find it incredible that the Fed would consider lowering its targets for monetarygrowth, in
light of the growing consensus among economists that slow growth of the money supply over the
past several years has been a major factor producing the current jobs recession.
Last February, the Federal Reserve set a target range of 21/2 to 61/2 percent growth for the
money supply during 1992, with a goal of reaching the midpoint of 41/2 percent For most of this
year, however, money growth failed to reach even the lower target Since the trough of the reces-
sion, the real money supply has actually fallen, in contrast to past recoveries when the Fed aggres-
sively expanded the real money supply by 6 to 16 percent and fostered much stronger economic
growth.
Experts from both sides of the political spectrum agree that money growth has been too slow,
and monetary policy too tight, for much of the recent past On December 30, the Joint Economic
Committee held a hearing on the conduct of monetary policy, and heard similar testimony from
two of the nation's foremost economists. Professor Paul Samuelson of MIT, who won the Nobel
Prize in Economics in 1970 - the first American ever to be awarded that prize - told the Com-
mittee:
Monetary pwlicy in 1 992 missed an important opportunity to lean against the wind of a con-
tinuing American growth-recession. Economic history textbooks of the fixture will attribute
George Bush's defeat and William Clinton's victory to Federal Reserve actions which, from
mid- 1990 to mid- 1992 were repeatedly too little and too late.
Professor Paul McCracken of the Universit>' of Michigan, a former Chairman of the Presi-
dents Council of Economic Advisers, testified:
The management of U.S. monetary policy thus far in the 1990s will not go into the annals of
central banking as a distinguished performance, it has been inappropriate for the economic
conditions of the country.
There is absolutely no justification for a downward revision in monetary targets at this time.
Inflation is both low and stable, and there is no evidence of impending acceleration. The inflation
51
rate in 1 992 was the lowest in the last 25 years but one. If anything, the current jobs recession and
the current problems in the financial system argue for faster growth in the money supply, not
slower. Following the Fed's suggestion that we lower our targets for money growth would only
compound the policy mistakes of the past, and condemn millions of Americans to continued un-
employment
It would be a sad irony indeed for the country to have voted to end the gridlock in economic
policy between the Congress and the President only to find it replaced with a new gridlock be-
tween an Administration and Congress committed to stronger growth and a Federal Reserve de-
termined to restrain growth by keeping its foot on the m.onetaiy brakes.
52
PREPARED STATEMENT OF THE HONORABLE MR. GREENSPAN
Mr. Chairman and Members of the Committee, as you loiow, the Federal Reserve will sub-
mit its semiannual report on monetary policy to the Congress in just a few weeks, after our up-
coming Federal Open Market Committee meeting. At that time, I will be in a position to address
more specifically our expectations for economic growth and inflation, and the ranges of money
and credit expansion that we anticipate to be consistent with the achievement of our goal of main-
taining maximum sustainable growth in the economy, by fostering a stable, noninflationary, fi-
nancial environment Under the circumstances, my opening remarks this morning will focus
primarily on identifying the major tendencies visible in our economy today.
The available data suggest that economic activity has been inaeasing at a firmer pace of late.
After rising at only about a 1-1/2 percent annual rate, on average, over the first five quarters of the
expansion, real gross domestic product increased at about a 3-1/2 percent rate in the third quarter
of 1992. The advance estimate of the Bureau of Economic Analysis for fourth-quarter growth,
which will be released tomorrow, is expected by many analysts to show a substantial gain as well.
Meanwhile, industrial production posted a healthy advance over the final three months of 1992,
with solid growth for a broad range of industries.
The recent news on the inflation fi-ont also has been quite favorable, as businesses have con-
tinued their efibrts to contain production costs and boost efficiency. All told, the inaease in the
consumer price index excluding food and energy-a measure that is widely used as a rough proxy
for the underlying trend of inflation-was just 3.3 percent over the twelve-month period ending in
December, a fiiU percentage point less than during 1991.
Although a number of economic indicators are distinctly encouraging, this is not to say that
we have clear sailing ahead. As I indicated when I appeared before this Committee last March,
households and businesses have been struggling to redress structural imbalances unparalleled in
the postwar period. The speculative bidding up of real estate and other asset prices over the
course of the 1980s fostered an excessive accumulation of debt and assets. The subsequent weak-
ening of asset prices in the early 1990s left the balance sheets of many households and businesses
strained with debt overload. Banks and other intermediaries that had financed the buildup suf-
fered losses that severely eroded coital. The pressures to work down debt, reinforced by under-
standably more conservative lending practices, slowed economic growth. Some time ago, I
likened tiiese pressures to head winds of 50 miles per hour.
Those head winds have now slackened somewhat But they have not disappeared. The proc-
ess of balance sheet adjustment, while becoming less of a restraint on the economy, will doubtiess
be with us for some time. In addition, we are coping with a sizable retrenchment in the area of na-
tional defense. And, although U.S. domestic demand appears to be improving, many of our key
trading partners are experiencing disappointing economic performance. This is acting as a drag
on our exports and our outputs.
Much of the strength suggested by the incoming U.S. data has been in the consumer sector.
The speed-up in consumption comes after a period of more conservative spending behavior,
when many households seem to have focused on paying down debts and shoring up balance
sheets, so badly pressured by the events of recent years. The relative strength of spending, thus,
may reflect the improvement that has been achieved to date in the financial health of households.
Debt-to-income ratios have fallen slightly, and debt servicing burdens have declined quite no-
ticeably, in large part because of the reductions in interest rates. At the same time, the value of
household financial assets has been buoyed by the rise in stock prices last year. Moreover, con-
cerns about housing prices, which probably were a key reason that consumers were so disti^essed
for much of the past few years, seem to have lessened.
The strengthening of the housing market also may be important in a more specific way. Sales
of single-family homes have picked up and when existing homes are sold, the capital gains that
usually have accumulated over time can be realized. The buyer of the home typically takes out a
mortgage greater than that paid ofFby the seller. The difference largely reflects the realized coital
gain of the seller who receives unencumbered cash, only part of which is apparently added to a
down payment on a subsequent home purchase. Such cash provides the seller with additional liq-
uid funds to spend on consumer goods and services.
53
History suggests that this is just what has been happening. The marlced rise in existing home
sales in recent months has addai to households' purchasing power by enabling them to realize
capital gains at an increasing rate, helping to fuel the growth in consumer spending. Homeowners
also have an opportunity to liquefy capital gains when refinancing an existing mortgage, and refi-
nancing surged in the latter part of 1992. Realized or liquified capital gains are not taken account
of in computation of the official saving rate, whose recent decline therefore probably overstates
the drop in the flow of saving as perceived by households. However, unless home sales, mort-
gage refinancing, and the associated equity extraction continue to rise, there is a limit to how
much longer this factor can fiiel the growth of consumer spending. The measured personal saving
rate is at a relatively low level, and fiarther outsized increases in consumption are not veiy likely
in the absence of a sustained pickup in income growth.
Consequently, a significant consideration, in terms of the outlook for consumer demand, is
the employment picture. The opfimism revealed in the recent surveys of consumer attitudes may
prove fleeting if overall labor market conditions remain subdued. Indeed, despite signs of modest
improvement in the past few months, since the recession trough in March 1991, employment has
shown essentially no net change on the payroll basis, and only a modest increase in the household
series.
Of course, the softness in employment in the current expansion is partly the counterpart of
another development-namely, a dramatic improvement in productivity. Since the recession
ended in early 1991, productivity has grown at an average annual rate of about 2-1/2 percent, a
better than expected performance given the relatively slow pace of the economic recovery to date.
The corporate restructuring and downsizing efforts that have been associated with the recent
productivit>- gains have in part been a response to the profit squeeze that emerged during the
1990-91 recession. They also have been spurred by increasing costs of health insurance and other
fiinge benefits, which have restrained hiring and encouraged a surge in the use of temporaiy
workers. But restructuring also seems to have reflected an effort to capitalize on new opportuni-
ties for greater efficiency. Although we cannot be sure how or why these new opportunities have
arisen, I suspect they are the product of the accelerating advances in computer software and appli-
cations. Past large accumulations of computer hardware did not seem to have the expected effects
on productivity. But a new synergy of hardware and software ^plications may finally be show-
ing through in a significant increase in labor productivity.
These far-reaching changes in the production processes in manufacturing, and in the means
by which services are produced and distributed, have apparentiy yet to run their course, though
one must assume that the pace of restructuring will surely slow. Accordingly, we may see less of
a tapering off in productivity gains in coming quarters than past cyclical experience would sug-
gest That prospect is highly favorable in terms of the longer-run potential output of the economy
and our international competitiveness, but it would also imply some continuing adjustments in
the work force in the near term.
The push to acquire state-of-the-art technology has also been providing a discernible thrust to
capital spending in recent quarters-and likely will continue doing so. Real outiays for office and
computing equipment have soared, as firms continue the transition to the more powerful and
cost-eflFective machines that are now available, and purchases of communications equipment con-
tinue to be boosted by. among other things, the shift to fiber-optic networks. Demand for other,
more traditional types of equipment now appears to be growing as well. The improved pace of
economic expansion has doubtless lifted sales expectations, and the marked increases in profits
and cash flow over the past year are providing funds for new purchases.
Problems, however, remain in a number of areas, though with some lessening of concem.
Chief among them are the ongoing difficulties in the credit area Depressed demand is doubtiess
the major explanation for weak loan growth at banks and many other intermediaries. However,
increased regulation presumably has also played a role. Moreover, lenders, seeking to protect
their capital positions, have been extremely cautious. Although they seem to have stopped tight-
ening credit terms, a significant easing is not yet evident
Commercial real estate has accounted for much of the asset quality problems at financial in-
stitutions. Until real estate values clearly stabilize, banks and other intermediaries are not apt to
become substantially more eager lenders. The liquidity of real estate markets remains impaired,
and lenders are uncertain about the value of collateral and the appropriate level of reserves against
54
nonperforming loans. The risk that further reserving may be necessary has led banks to bolster
book capital, widen lending margins, and approach new credits with caution. It is not necessary
for real estate values to rise to reduce this risk, but lenders need to be more confident that prices
will not continue to fall and that, if necessar/, they can sell collateral expeditiously at reasonably
predictable prices. While there are some initial signs that commercial real estate niarkets in some
regions are finding a bottom, uncertainty remains high. Having accumulated substantial liquid as-
sets and rebuilt capital, banks seem well positioned to meet increased loan demand, especially
once collateral uncertainty diminishes. Endeavors by both the Resolution Trust Corporation and
private parties to encourage the development of a secondary market in commercial mortgages
will help liquify the market in commercial real estate itself However, should problems in com-
mercial real estate persist, credit conditions for small and riskier business may ease only gradually
for some time.
Soft property prices, engendered by high vacancy rates and sluggish demand for space, are
likely to continue to restrain commercial construction spending in 1993, and the prospects for
multifamily housing are not much better. In addition, budgetary pressures on state and local gov-
ernments remain intense.
Meanwhile, we must continue to woric through the sizable adjustment in militaiy spending
that has been under way since the late 1980s. From a longer-run perspiective, the defense cut-
backs carry the anticipation of substantial benefits for the U.S. economy. By fitting up resources
that can then be devoted to improving the nation's stock of productive physical and human capi-
tal, they should ultimately lead to higher living standards, hi the short run, of course, lower de-
fense spending is a depressant on economic activity, and on jobs and incomes. For industries and
regions that rely heavily on military spending, the dislocations may well be sizable. In industries
that depend on defense expenditures for at least 50 percent of their output, employment has fallen
more than 20 percent (300,000 jobs) since 1987. And, in Califomia, where the share of civilian
employment in defense-related jobs may be almost twice the national average, the unemployment
rate has risen to about 10 percent, nearly 3 percentage points above the national average.
In addition, our export performance is being restrained by developments abroad. Countries
that earlier had been growing at least moderately have shown clear signs of slower growth, or
outright declines, in economic activity. In both Germany and Japan, real output fell for part of
1992, and growth for the year as a whole was substantially less than in 1991. Many of the other
countries of continental Europe have recorded only weak growth. And in Canada and the United
Kingdom, signs of recovery from prolonged recession have ranged between weak and elusive.
Foreign officials have reacted to these developments with measures intended to boost spend-
ing and to promote recovery. In Japan, official interest rates have been lowered nearly 3 percent-
age points since the start of 1991, and a supplementary budget of additional government
spending has just been passed. \n Germany, the choice of policy steps has been complicated by
the special circumstances associated with the massive task of unifying the economies of eastem
and westem Germany. Monetary conditions have been eased somewhat, but continued rapid
money ? growth and persistent inflation have made officials cautious. In the other European
countries tied to Germany through the exchange rate commitments of the European Monetary
System, scope for aggressive monetary easing has been limited. This has led some countries to re-
lax that commitment, at least for a time, and to ease monetary policy.
I will, of course, be discussing Federal Reserve monetary policy in detail when I present the
System's Humphrey-Hawkins Report to the Congress next month. However, let me comment
briefly on an issue that has arisen recentiy with regard to the ranges for monetary growth in 1993.
The issue, as I indicated in my letter to Senator Sasser earlier this month (attached), is that an un-
usual portion of aggregate, spending has continued to be financed by credit granted outside of
banks and other depositories-evidentiy a side effect of the process of the balance sheet restructur-
ing that I referred to earlier. Should the phenomenon persist in 1993, it implies that growth in M2
consistent with our broader economic objectives would be slower than indicated by normal his-
torical relationships of money and spending-and that a technical adjustment to our monetaiy
growth ranges might thus be in order. That assessment is wholly technical and should not be in-
terpreted as indicative of any change in monetary policy pe[ s£- Partly in view of these develop-
ments, the Federal Reserve can not rely exclusively on money supply growth relative to its targets
in formulating monetary policy. In any event, the Federal Open Market Committee will
55
reexamine this issue, along with other, broader considerations, when it meets next week to set
monetar) polic>- goals for 1993.
Regardless of the specific ranges established for the growth of money and credit over the
coming >ear, the objectives of monetary policy remain unchanged: We are seeking to foster fi-
nancial conditions that will encourage maximum sustainable growth in the economy. As I, and
my colleagues, have stressed, a noninflationary environment is a precondition to such a goal. For
the coming year we will continue playing a constructive role in supporting an extension of the re-
cent more hopeful signs of solid growth, while endeavoring to avoid any excesses that might lead
to a flare-up of inflationary pressures down the road. Such a course will help the economy
emerge from the financial difficulties of recent years, maintain the progress toward price stability
that has been achieved thus far, and thereby promote a sustainable economic expansion.
56
ATTACHMENT TO THE HONORABLE MR. GREENSPAN'S TESTIMONY
BOARD OF GOVERNORS
□ F THE
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 2Q5SI
January 8, 1993
ALAN GREENSPAN
CHAIRMAN
The Honorable Jim Sasser
Chairman
Committee on the Budget
United States Senate
Washington, D.C. 20510
Dear Mr. Chairman:
I appreciate having your views on the Federal Reserve's
M2 money supply target for 1993. I want to emphasize that the
issues I was addressing in my letter to Chairman Gonzalez were
wholly technical in nature. In discussing possible reductions in
the ranges, I was not signalling any lessening in the Federal
Reserve's commitment to fostering financial conditions most
conducive to the sustained expansion of the U.S. economy with the
highest possible levels of employment and output over time. Nor
was I endeavoring to indicate any change in monetary policy per
My observations were directed solely at the statistical
problems we are having with our money supply aggregate measures,
and their ability to appropriately track developments in the
economy. That relationship is best represented by M2 velocity
(the rate of money turnover, or nominal GDP divided by M2) . This
ratio increased substantially in 1992, despite continued declines
in market interest rates, which usually are associated with
falling velocity (see chart) . Through the first three quarters
of 1992 nominal spending increased at around a 5 percent annual
rate, while M2 rose at only a 1-1/2 percent rate. A further
increase is indicated for the fourth quarter of 1992.
We believe that these extraordinary increases in
velocity reflect changes in the way spending is being financed.
In response to the stresses of recent years, lenders and
borrowers have taken steps to strengthen their financial
situations. In the process, they have emphasized rebuilding
capital, paying down debt, and raising funds in longer-term debt
and equity markets. A side effect of this restructuring is that
spending has been financed to an unusual degree outside of banks
and other depositories, whose liabilities constitute the bulk of
the monetary aggregates. As a counterpart, induced by higher
yields, savers have channelled funds directly to borrowers via
investments in longer-term debt and equity. This means that M2
57
and M3 as ways of financing economic activity are being replaced
in part by alternative financing vehicles without impairing the
economy's growth potential. The statistical result is that M2
and M3 velocities have risen; another is that we are making
significant progress toward more comfortable financial condi-
tions, which will help to support economic expansion. Still, it
is unlikely that this process has reached an end, and its con-
tinuing influence on the statistically measured velocities of M2
and M3 will have to be taken into account by the Federal Open
Market Committee when it considers the 1993 ranges in February.
I will be circulating your letter to the other FOMC
members so they will be fully aware of your views when they con-
sider the ranges at their next meeting. I am enclosing a staff
study of M2 velocity behavior, and would be pleased to have our
staff brief you or your staff on the technical reasons for the
ongoing statistical increases in M2 velocity. I hope you have
found these comments useful.
Sincerely,
(signed) Alan Qreeoflpaa
Enclosures
58
WRITTEN OPENING STATEMENT OF SENATOR CRAIG
MR. CHAIRMAN, I am pleased and honored to join you today as a new Senate member of
the Joint Economic Committee. I have had a longstanding and intense interest in our nation's eco-
nomic health in general. In particular, I look forward to exploring on this committee how our
econom>' is affected by the fiscal and regulatory decisions made by the federal government I also
have had a longstanding interest in major sectors of our economy, such as energy, agriculture,
health care, and trade. "Hiese sectors are important not only in the Northwest, but all across our
nation.
I look forward to participating with my colleagues from both sides of the aisle and both
chambers in full and far-ranging discussions of the perils and the opportunities that face our econ-
omy.
I want to join my colleagues today in welcoming Dr. Alan Greenspan to our hearing. Dr.
Greenspan, you have had an accomplished and distinguished career in both explaining and influ-
encing how the government affects the economy.
I note with interest that you toured for a year as a tenor saxophone player with the Henry
Jerome band, after studying music at JuUiard. 1 hope this is an positive omen of the music you
and the new administration will make together. Given your commitment to economic growth,
sound money, and deficit reduction, I hope you're the first chair in this new sax section.
I'm sure that you're going to talk to us today, in part, about the need to reduce the federal
budget deficit As you and we attempt to take an overview of the economic outlook, deficit reduc-
tion doesn't deserve special attention, it deserves preeminent attention.
Just yesterday. Dr. Robert Reischauer of the Congressional Budget Office told the Senate
Budget Committee that the current, "lackluster [economic] expansion and large budget deficits
are not merely coincidental. Living standards are projected to grow more slowly, in part, because
of the decline in the national saving rate over the past decade. And the federal budget deficit had
been a major contributor to that drop...."
He also said that, "Under current budgetary policies, the deficit will climb from $310 billion
in 1993 to ... about $650 billion in 2003.... Federal debt would then represent almost 80 percent
of GDP, higher than at any time since the aftermath of World War II." In the same vein, the Gen-
eral Accounting Office last year concluded that if we complete the odyssey to a balanced budget
by the year 2001, Americans' living standards will be about a third hi^er in the year 2020; but if
we do nothing, the next generation will have a standard of living, at best no higher than today's. I
find such figures astounding and sobering. They make ever- clearer the need for this Congress to
pass the Balanced Budget Amendment to the Constitution and send it to the states for ratification.
Every time that Congresses and Presidents have grounded their fiscal resolve in a mere statute, it
has dissolved as a matter of political inconvenience.
We came very close to passing the Balanced Budget Amendment last year and 1 believe we
will pass it in the 103rd Congress. I'm convinced ~ and a growing number of converts in and out-
side of the Congress are convinced - that no lesser constraint will be effective in preventing us
from, as Jefferson said, unjustly "saddling our posterity with our debts." 1 don't expect you neces-
sarily to comment on such specific budget process reforms, but I do hope you will comrnent on
these recent, bleak, deficit projections and on die need for deficit reduction as a precondition to
substantial monetary stimulus of the economy.
Mr. Chairman, 1 also want to make the point that, as we examine various aspects of the
budget deficit and the larger economic picture, there needs to be a thorough study of health care
reform. Medicare, and Medicaid. I am concerned about the startling figures quoted by Dr. Reis-
chauer in his testimony yesterday. He stated that Medicare and Medicaid represented 3.4 percent
of GDP in 1992 and will grow to 5.1 percent of GDP by 1998. These figures are very fioistrating.
Our expenditures are growing quickly, yet health care providers in my state of Idaho continue to
get reimbursed at below cost rates for many Medicare and Medicaid services. Health care reform
is high on the public policy agenda; therefore, it is important that we have a good understanding
of how current government involvement is affecting health care costs and access. We can not re-
form our system without this analysis and a better understanding of how we can provide access to
those who are now in the ranks of the uninsured, without flirther contributing to the deficit I be-
lieve it would be of vital importance for this committee to hold hearings in this area in the near fu-
ture.
THE 1993 ECONOMIC REPORT OF THE PRESIDENT:
REVITALIZING THE ECONOMY
Thursday, February ii, 1993
Congress of the United States,
Joint Economic Committee,
Washington, DC.
The Committee met, pursuant to notice, at 10:00 a.m., in room 2359, Ray-
burn House Office Building, Honorable David R. Obey (Chairman of the
Committee) presiding.
Present: Representative Obey and Senator Sarbanes.
Also present: Lee Price, Charles Stone, Glen Rosselli and Chris Frenze,
professional staff members.
OPENING STATEMENT OF REPRESENTATIVE OBEY,
CHAIRMAN
Representative Obey. Good morning. Today, the Joint Economic Commit-
tee is beginning a series of three hearings to examine the current state of the
American economy and the economic challenges that confront President Clin-
ton and his new administration.
For the benefit of the young people in the audience, I don't want you to
think that because you don't see a lot of members of Congress here, it means
they are slacking off. The fact is that Congress is in recess, and I simply stayed
in town to run these hearings because I thought that Congress ought to be
examining, in a public way, some of the same dilemmas which the President is
examining as he makes his final decisions about the budget for the coming
few years.
We now have a new President, and we have a very new Congress, with
some 110 new members in the House and 12 new members in the Senate,
and we have a country which is demanding change. Last night President Clin-
ton listened to Americans talk about their hopes and concerns at a to'v^Ti meet-
ing in Detroit, and as I said, over the course of the next few days, the
President will be putting the final touches on the economic proposals which
he will be presenting to the Congress in the State of the Union message on
the 17th, and on his budget about a month later. And over the course of the
next year, and probably for far longer than that, we will be engaged in a de-
bate about what that change should be and what direction our country ought
to take.
The purpose of these hearings is to try to paint a clearer picture of the cur-
rent shape of the economy, the shape it will be in if we don't take action, and
the options before us to make things better. Today and tomorrow the Joint
Economic Committee will discuss these problems and issues, and the Presi-
dent at the same time will be making his choices.
I think the best way to understand the problem confronting us is to recog-
nize that we really have four deficits which have afflicted our economic per-
formance during the past 12 years, and in my view many of them afflict us
going all the way back to 1973. 1 would like to use some charts before we hear
(59)
76-207 0-94—3
60
from our distinguished panel this morning. I would like to use them in order
to try and demonstrate what those four deficits are all about. Before I do so, I
want to make clear that these numbers and graphs are important only insofar
as they tell the story of what is happening to real people in the real economy.
The first chart is the one that is most familiar to the general public, I think,
and to most members of Congress. It demonstrates what has happened to the
federal deficit since 1945. (See chart below).
Budget Deficits
Fiscal Years 1945 to 1993
350
1945 50 55 60 65 70 75
Fiscal Year
Source: Oftlce of Management & Budget; Congressional Budget Office
80 85 9093est
As you can see, going from 1945 on up through about 1980, we never had
a deficit which exceeded a litde over $70 billion. I will never forget, for in-
stance, in 1980 when a number of congressional leaders met in Bob Byrd's
office for three weeks, because we had been told by Paul Volcker, the Chair-
man of the Federal Reserve, that if we did not cut President Carter's deficit
by $16 billion, the sky was going to fall and the world was going to come to an
end, because we could not afford to have a deficit of $60 billion. Well, we cut
$16 billion out of the deficit, but the deficit did not go down because the
economy weakened.
I think there is a lesson in that for congressional and presidential policy-
makers as we proceed to tackle today's deficits. You can see up until 1980, we
never exceeded $74 billion in deficits. You can see since that time that the
nominal deficit has exploded.
61
Now, when we were at this point at the beginning of 1981, President Rea-
gan proposed apian to Congress, which he told us would eliminate the deficit
in four years. That plan essentially consisted of doubling the military budget
over a specific period of time. It also consisted largely of some very large tax
cuts, especially for high-income people.
The green numbers on this chart demonstrate what we were told at that
time by the Administration as to what would happen to the deficit if we
passed the Administration's recommendations in 1981. The red lines indicate
what the numbers actuaUv wound up being in 1987, 1988, 1989 and 1990. As
you can see, a considerable variance between the promise and the perform-
ance of the economy.
I believe that the most meaningful way to look at our fiscal situation is to
take a look at the historical pattern of debt by the government, and this chart
demonstrates that at the end of World War II, in 1945, we had a debt that
exceeded the annual total national income of the United States. That de-
clined steadily over a period of years until about 1973, and it got down to
about 24 percent of our annual national income. (See chart below).
Federal Debt as a Share of GDP
120%
100%-
80%-
60%
40%-
20%
0%
1946 1955 1964
1982 1991
It stalled between 1973 and 1980, and then after the budget decisions in
1981, the percentage of our annual national income began to significandy rise
again to a point where it has almost doubled the level where it was at in 1980.
This next chart demonstrates that debt did not just increase in the govern-
mental sector. This chart demonstrates that we had a significant increase in
private debt, as well, in the economy during that same period. It was rising
slowly between 1945 and 1980, and then it began to shoot off the graph in the
62
1980s, with serious consequences for us all. We also at that time, in interna-
tional terms, went from having the rest of the world owe us large amounts of
money to having us owe the rest of the world a good amount of money. (See
chart below).
Debt of Private Nonfinancial Sector
Percent of GDP
80'
Nonfinancial Businesses
Government
lllllllllilMIIIMI IIIN III IIMMIIIIIIIIIIMIIIIIIIIIII IIINIIIIIIMIIIIII IMIIIIIPMIIIIMIMIIII lllllllllllll IIMIIIIlll llllllllllliniMIIIIIII llll I IN IMII illl'
1955 1960 1965 1970 1975 1980 1985 1990
Now, that demonstrates what has happened on the issue of debt. This
chart demonstrates that we have a second deficit which we also need to tackle
if we are going to succeed in confronting the economic problems before us.
This chart demonstrates that in 1980 the investment share of the federal
budget — and by that I don't mean consumption items — I mean what we in-
vest in children by way of an education, what we invest not in health care but
in health research, what we invest in science research to stay at the cutting
edge of technology, what we invest in physical infrastructure to create the
kind of physical grounding that is needed for communities to prosper. This
demonstrates that if you break up the budget into those kinds of categories,
the investment portion of the budget, represented by this green piece, de-
clined from 16 cents out of every federal budget dollar in 1980 to about nine
cents out of every budget dollar at the end of the decade. That is more than a
40 percent decline. And I think that this deficit in investment — this disinvest-
ment, if you will — is every bit as significant to our economic problems as is the
federal budget deficit which gets so much attention. (See chart below.)
63
Shrinking Federal Investment
Invwtmert 16%
a«n«m Govn 3% -
imcraM 9% J
Ecorramie StiMlty S% -
Nop tKHfiY poo* 7X
FY 1980
Investment 9%
G*n«nl Govt 2%
Intamt 14%
Economic SUb4my4%
Non Hdflypoof 8%
FY 1992
And, again, this next chart demonstrates that that disinvestment did not
just occur in the pubUc sector. It has occurred in the private sector as well.
(See chart below.)
Real Net Nonresidential Investment
Percent of Real Net National Product
1 -l-I— I 1 ' 1 1 ^ 1 1 T 1 I I 1 I I I I 1 I I I I I I I I 1 I I ' ' ' ' I ' ■ . . I ■ I '
1950 1960 1970 1980 1990
64
It is hard to follow a chart which moves around as much as this has, but
what this line is meant to represent is what the average net investment was in
this country between 1946 and 1988, riding at somewhere between 6 and 7
percent. It has really dropped off the graph since that time, and I think this
indicates that you simply had a strong worsening of what had been a slight
downward trend up until that time.
Now, if you take a look at nondefense research and development, this is a
percentage of our total income each year, you see this blue line represents the
investment trend in Germany and in West Germany, and as you can see it
was rising from about 2 percent of Gross National Product to almost 2.8 per-
cent today. As you can see, Japan has had a steady rise in their investment as
a percentage of their national income starting in 1979, just a steady rise. (See
chart below.)
Nondefense Research and Development
Percent of GNP
3.a
2.8-
2.6-
2.4-
2.2-
2.(H
1.3
^■&i
1.4-
West Germany
N.
United States
I I I 1 I I 1 I t I 1 I I — _ I I I
1975 1980 1985
The United States, a slight rise between 1980 and 1985, but as you can see,
a much smaller effort than their economic competitors. And over time, in my
view, and I think in the view of most people, we are going to pay a significant
price for that gap.
Now, so much for the investment deficit. We also have a third deficit, in
my view, and that third deficit is what I would call a growth deficit. This chart
has arranged the historical growth of the American economy in descending
order by each President's four-year term. (See chart below). And as you can
see, in Truman's only full term, real economic growth was about 25 percent.
65
Now, that was due in very large part to the pent-up energies at the end of
World War 11, but under Kennedy and LBJ — it was Jack Kennedy's first term,
which Johnson completed after Kennedy was assassinated — you still had very
rapid economic growth. In Johnson's second term, the same thing occurred.
In part that was added to because of the Vietnam War. We had very strong
growth in Reagan's second term. Then Nixon's first term comes after that in
terms of growth.
Economic Growth by Presidential Term
0.0%
Increase in Real GDP
5.0%
10.0%
1 5.0%
Percent
20.0%
25.0%
30.0%
In descending order, before the Bush four-year period, the lowest period of
real economic growth occurred under Dwight Eisenhower. And as you can
see, we have been trailing the pack for the last four years. That has resulted in
this pattern for employment growth.
Again, this chart is arranged in descending order showing that you had the
fastest growth in jobs in any four-year period under Johnson, over 16 percent
growth in jobs during his four-year term. Carter's term was the next largest job
growth period. Truman's term was the third largest. Reagan's second term
produced 1 1.5 percent growth in jobs.
You can see, again, before the last four-year period, the slowest job growth
period was under Eisenhower, both his first and second term, and again the
last four years trailing the pack.
This chart demonstrates what has happened in jobs in a litde different way.
The blue line — and this has been used by Senator Sarbanes many
66
times — represents the average of the eight previous recoveries from recession
in terms of job growth. (See chart below).
Employment Growth
During 4-year Term
Johnson
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^Bl6.6%
Cartef
B
IB
^^mmm
^^^^|l2.9%
Tmman
mn
■^■■IH
^^|l2.1%
Reagan 2
^H
■IHHH
Hll.5%
JFK/LBJ
■1
M^BBBB
|11.0%
Nixon 1
^H
|^BmBBB9.o%
NIxon/Ford
■1
HH
^^^^6.6%
Reagan 1
^H
^■6.0%
Elaanhower 1
IHI
■ 5.5%
Eiaanhower 2
Bush
1.4%
1.3%
0
K
2%
4%
6% 8% 10%
Percent
12% 14%
16% 18K
Source: Bureau of Labor Statistic*; Joint Economic Commme*
"What this chart demonstrates is that some 22 months after we hit bottom
in the eight previous recessions, we had recovered all of the job loss that had
occurred and were on our way to creating a good number of healthy jobs.
Whereas in the current recovery, there is barely any recovery at all in terms of
job growth, and that indicates that while we may have some promising signs in
terms of some of the economic indicators but in terms of that progress being
translated into real progress for families looking for work, we have not had
very much progress. So I think this shows what has happened with what I call
the growth deficit. (See chart below).
67
5-i
4-
3'
2
1
0
Nonfarm Payroll Employment
Percent Change from Trough
8 Business Cycles y
Since World War II .♦*
1989-1992
-1 ' I I I I I I 1 I I f I I t I I I I I I — I I I I I I I I I I I I I I I I I I I I I I I I I — r-i— t— I— r
Trough-2Yrs Trough-1Yr Trough Trough+IYr Trough+2Yrs
Because of all of these factors, you also have an income deficit to American
families. This chart represents what happened to real hourly compensation for
all workers in our society going back to 1958.
This chart demonstrates what has happened to the real level of compensa-
tion for all workers when you include both wages and fringe benefits, and it
shows that in the early 1970s or mid-1970s, we stalled out, climbing rapidly
up until that time. And we stalled out at that point and have been trying to
move it up since, but haven't really gotten it there. (See chart below).
68
Real Average Hourly Compensation
Production & Nonsupervisory Workers
10 T
40 niii III III 111 II I III II I III III III II Mini I III III III II 1 1 II II 1 1 II II II II iiM II III III III I II iM I II III III III III III III Ml II I III III iiMi I iiMiiiiMi I III II I III III I iimi II iiM II Ml III iinm^
1947 1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992
Now, when you take a look at the next chart and you take fringe benefits
out so that you are only looking at compensation for workers in this economy
who are not managers, you can see that we have had a significant decline in
average hourly earnings at about $7.80, but not quite. In 1980, it dropped
significantly, got back up to that point in 1986, and since then it has been de-
clining. So I think what that demonstrates is that the country as a whole has
been in big trouble in terms of average hourly earnings, certainly for the last
six years, and I believe the problems began as far back as 1973. (See chart
below).
69
Real Average Hourly Earnings^
1982 Dollars per Hour Worked
7,4-
7.3 1 MMIIIIIITlIt
I iiiiiiii nil III
■'^ ''''"' """'"" " iiniiTTTrTTiiii niiiiMiiii Ml iiii IN HUM nil n III liu III III III I II III nil III II III nil III III III iMiii Mil Tim III Ml nil Ml II'
1 980 1 981 1 982 1 983 1 984 1 985 1 986 1 987 1 988 1 989 1 990 1 991 1 992 1 993
■ Production and non-supervisory workers
This chart demonstrates that the squeeze on income has not fallen evenly
on families or on workers. This chart demonstrates the change in the share of
total national income from 1980 through the end of the decade, and as you
can see, the bottom fifth has a significant decline in their share of national
income. The next bottom fifth also had a significant decline. (See chart be-
low).
Change in Share of Aggregate Household Income by Quintile
1980 to 1989
8.0%
Lowest fifth Third fifth Highest fifth
Second fifth Fourth fifth
70
You don't reach a point at which people improve their share of national
income until you get to people who are in the top 10 percent of income levels
in this country. At this point, once you get here, above the 91st percentile, you
begin to see an increase in those worker's share of national income, and the
people who have really cleaned up are the people in the top 1 percent. They
have had almost a 40 percent increase in their- share of national income over
the past 10 years.
I think those charts pretty much tell the story. People may quibble with
some of them, but I think those charts in the main tell the story about what
has happened in this country on the four deficits which President Clinton will
be wrestling with: The budget deficit, the investment deficit, the growth defi-
cit, and the family income deficit. And the purpose of these hearings is to try
to get some advice this morning about how we might go about attacking these
four deficits as the President puts together his budget and economic propos-
als, and as the Congress considers those proposals.
I think that we have to remember that in the end, economic growth is not
an end, in and of itself. Economic growth is simply a way by which we can
assure a higher standard of living and a better and more fair and a more de-
cent society for all of our people; it is an instrument rather than an end in it-
self. The purpose of these hearings is to try to make clear that there is more
than one problem to solve and to try to get some good advice on how to solve
them.
And with that, let me simply ask our three distinguished guests to give us
their best advice this morning.
We have with us Professor James Tobin, Department of Economics, Yale
University, a Noble Laureate in Economics; Professor Robert Solow, Depart-
ment of Economics, Massachusetts Institute of Technology, also a Noble Lau-
reate in Economics; and Professor Allan Meltzer, Graduate School of
Industry, Professor of Political Economy and Public Policy, Carnegie Mellon
University.
Gentlemen we are happy to have all three of you here, and why don't we
begin with Mr. Tobin.
STATEMENT OF JAMES TOBIN, PROFESSOR OF ECONOMICS,
DEPARTMENT OF ECONOMICS, YALE UNIVERSITY;
AND NOBEL LAUREATE IN ECONOMICS
Mr. Tobin. Thank you, Mr. Chairman.
I submitted, as a statement to the Committee, my talk at the Little Rock
Economic Conference in December. I am not going to read that, although it
explains my general point of view on the problems you were speaking about
just now. I have also made available a set of charts that I am going to refer to
in my oral remarks.
I was here at a similar hearing just about a year ago. At that time, I advo-
cated a macroeconomic stimulus to get a vigorous recovery going, and at the
same time I advocated making provisions for deficit reduction which wouldn't
come into effect until the economy was well along in the recovery two or three
years later. I stressed the importance of encouraging both private and public
investment, and I stressed that any fiscal stimulus in the short run needed for
increasing demand and invigorating the recovery should take the form of in-
vestment outlays that would do good things for the quality of jobs and for
71
future standards of living. Those investments would be both private and pub-
lic.
For that reason, I recommended at that time an investment tax credit, a
revival of that investment incentive, and a program of fiscal assistance to state
and local governments where much-needed public investments in infrastruc-
ture and education could be implemented. I recognized at that time that ex-
pansionar)' monetary' policies may not be as potent as in previous business
cycles, but I urged the Federal Reserve to lower further the interest rates over
which it has immediate control. And I suggested that both the Federal Re-
serve and the Treasury take actions to reduce the stocks of long-term federal
securities in the hands of private investors. Those proposals were similar to
ones that were being offered at the same time by Senators Sarbanes and
Sasser and also advanced somewhat earlier by my fellow witness today, Rob-
ert Solow. In March 1992, Mr. Solow and I, along with other economists,
uTote an open letter to Congress, to the President and to the Federal Reserve
Board of Governors, along the same lines as I just outlined. We obtained the
support of 100 economists for that package. It is also the kind of program I
was arguing for in my statement in Little Rock in December, in the paper that
I have submitted to the Committee. I still support that program, and I want to
explain why.
I realize that economic news in the past couple of quarters has been better,
much better, than it had been through most of 1992, and indeed through
most of 1989 to 1992, for that matter. As a result, many people now reject any
further stimulus from either monetary or fiscal policy, and would make deficit
reduction the highest and even the more immediate priority. Some economists
have said that deficit reduction expected in the future would be a sufficient
stimulus for bringing about recovery now. I think that puts things upside
dowTi.
You said in your introductory remarks. Congressman Obey, that economic
growth is not an end in itself but a means of implementing higher goals for the
society, and I agree. I also think that deficit reduction is not an end in itself
but is a means to produce economic growth in the future and to improve the
standards of living of our children, grandchildren and their grandchildren. But
if deficit reduction is undertaken at the wrong time, the things that you have
to do to obtain it can cause unemployment and abort economic recovery.
That won't do any good at all for any future generations.
I would stick with fiscal stimulus in the first couple of years ahead of us,
even if it somewhat increases the deficits in the budget over those two years.
At the same time, as I advocated before, I would make as much headway leg-
islatively as possible to put into place deficit reduction measures to occur in,
let's say, 1995 and 1996, and future years.
I want to explain the reasons for my views. For one thing, I don't think re-
cover)' is by any means in the bag, despite the news we have been getting. I
think we have quite a long way to go before we restore fuU employment.
There is little risk that a modest stimulus package will overheat the economy.
There is minimal risk in the foreseeable future of any serious increases in the
rate of inflation.
There are a number of reasons for worries that the expansion of demand,
after the spurt of the last two quarters, will slow down. Some late 1992 in-
comes and spending, especially for consumption, were borrowed from 1993.
72
Twenty-four billion dollars in less withholding tax taken out of salaries and
wages in 1992 means that there will be smaller tax refunds and higher tax li-
abiSties in April 1993.
While that may have been foreseen by many people, its squeeze on liquid-
ity could have some negative effects this year, the counterpart of any positive
effects it had last year. Some reports say that bonuses and other incomes mov-
able from one year to another were shifted forward in anticipation of higher
marginal tax rates in 1993.
I think some other factors are more important. The prospect for United
States exports are dubious because of the weakness of the economies of our
principal major trading partners in Europe and the Far East. Ironically, we
could also be harmed, at least for several quarters to come, by the belated ef-
fects of those countries to stimulate their economies.
As their central banks lower interest rates, they may cause our dollar to ap-
preciate again. If we had our druthers, we would have those countries stimu-
late their economies by fiscal rather than by monetary policy.
Consumption spending has been running ahead of incomes in the latter
part of 1992, especially ahead of wages and salaries. The fact that employ-
ment has lagged, as one of your charts showed dramatically, means that the
incomes to support higher spending have not been generated by jobs. Without
jobs or the expectations of jobs, demand could weakening.
One big question is how much room there is in the economy for expansion
of gross domestic product before we get unemployment back down to 5. 5
percent or lower. I think the GDP gap that we have right now is — the gap
that corresponds to an excess of around two points in the unemployment
rate — is about 5 percent of GDP, or maybe even more. To eliminate a GDP
gap of 5 percent in 1996 would mean that annual growth during the next four
years would have to be, on average, 1.23 percentage points higher than the
normal sustainable growth rates — one-and-a-quarter being one quarter of five.
The sustainable growth rate is the growth rate that you can sustain, with a
more or less constant rate of capacity utilization and of unemployment, by the
normal growth of labor force and of productivity. That rate is what I would
think is around 2. 5 percent. Adding the two and a half, which is that estimate
of the normal growth rate, and the one and a quarter needed to make up the
gap, means we need a 3.75 percent average annual growth rate during the
coming four years.
In contrast, the blue-chip consensus forecast for 1993 is much lower than
that, 3. 1 percent. I submitted some charts that bear on this, on these points.
In my package. Figure 1 shows how much the growth in GDP has lagged
behind in this so-called recovery since the trough in March 1991. It has lagged
behind normal growth in a recovery, the average over the seven previous re-
coveries. That is very much like the chart that Bob Solow used in Little Rock
and a similar JEC chart.
The next one in my packet is one of your own. It shows the dramatic lag in
job creation during this recovery compared to the previous ones.
The third figure in my little package — actually labeled Figure 2 — shows
GNP, because it starts back before GDP was available, real GNP in dollars.
"Potential" real GNP is estimated as a smooth trend. A break in that trend is
put in at 1973, with 3. 3 percent growth before and 2.5 percent after. The
73
wiggly cyclical path is that of actual real GNP, which is usually below poten-
tial and sometimes above.
The times above were the overheated years of Korea and Vietnam, where
unemployment was probably unsustainably low. Potential, as I estimated it,
happens to correspond to 4 percent unemployment in the pre- 1973 earlier
period and to a higher rate, 5 percent or a little more, in the later period.
The next chart, tided Figure 3, shows the GNP gap, which comes from the
previous figure. In Figure 3, it is compared with the unemployment rate. They
move together qualitatively quite well, and turn pretty much at the same
times. However, the amplitude of the GNP gap is much greater, about two-
and-a-half times greater, than the amplitude of the unemployment rate. The
implication is that to improve the unemployment rate by 2 percentage points
in four years would require a 5 percent increase in GDP, on top of normal
sustainable growth.
This relationship is often known as Okun's law, after the late Arthur Okun
who was the Chairman of the Council of Economic Advisers in the Johnson
Administration. When Bob Solow and I went to Washington with Kennedy in
1961, Art Okun joined the staff and did the work that led to this analysis.
It will take about nine million jobs from 1992 to 1996 to achieve this recov-
ery in GNP, or GDP. That includes re-employing many workers now unem-
ployed, many currently discouraged workers now who are not even counted as
unemployed, and also taking care of the normal growth of the labor force,
around 1 Va million a year, or five million for the four years.
In Figures 4 and 5, I am trying to show how this recovery differs from pre-
vious business cycles, how labor markets are weaker than they appear to be if
judged by the unemployment rate alone.
First, as we all know, much of current unemployment comes from perma-
nent job losses rather than from reversible layoffs. An unusually large group
will never be re-employed in the same jobs or by the same employers. In Fig-
ure 4, the tide "Layoff and Total Unemployment Rate" should read "Perma-
nent Layoff and Total Unemployment Rates." The permanent layoffs
unemployment rate is a much higher number now, especially relative to the
total unemployment rate, than in previous periods.
The last figure repeats those two unemployment rates — the permanent one
and the usual one — and compares them to a job vacancy index. The vacancy
index is a ratio of the help wanted index to an employment index, normalized
so it can be put on the same chart as the two unemployment rates.
The point is that the vacancy index is a lot lower than one might have ex-
pected it to be at the rates of overall unemployment that we are seeing. The
jobs just aren't out there. New demand that will translate into new and re-
placement jobs is more problematic than it has usually been in recoveries. It
may take, in many cases, an investment in different industries and in different
locations to provide those jobs.
The second question in your letter of invitation concerned productivity. We
have had some good news lately about productivity. It is good in the sense
that it may signal some permanent increases in productivity and in the rate of
growth of productivity, not just the usual cyclical phenomenon. The usual cy-
clical phenomenon is that apparent productivity rises early in business cycle
recoveries because there are overhead workers on payrolls and redundant pro-
duction workers on payrolls who can begin to produce once sales revive.
74
There are probably not so many of those surplus employed workers now.
There has been plenty of time and incentive to shed those workers over the
past three years, and we read daily about companies doing so. The workers
are still there, not necessarily unemployed, but out of the labor force tempo-
rarily.
Some of the productivity gains that we have recently observed in 1992 and
1991 are probably good signs for the future growth. But they will only be
beneficial to the economy if we actually use them by employing the displaced
workers, instead of wasting them in higher unemployment for long periods of
time. So there may be more room for expansion of GDP than the calculations
that I reported above suggest.
Thank you very much.
[The prepared statement of Mr. Tobin starts on p. 102 of Submissions for
the Record:]
Representative Obey. Mr. Solow, please begin.
STATEMENT OF ROBERT SOLOW, PROFESSOR OF ECONOMICS,
DEPARTMENT OF ECONOMICS, MASSACHUSETTS INSTITUTE OF TECHNOLOGY;
AND NOBEL LAUREATE IN ECONOMICS
Mr. Solow. Thank you. It is a real pleasure to help start off this year's se-
ries of Joint Economic Committee hearings, and I want to thank the Commit-
tee for the opportunity, and I am not just being polite when I say that.
Many people, not just a few economists, hope that the way is now open to
cautious and thoughtful activism in economic policy. And it is a privilege to be
asked to make a contribution to that process.
We hve in the short nm, and I am sure that most of your discussions in
these hearings will be about the immediate prospects for our economy, about
the size and shape of the appropriate fiscal stimulus, if there should be a fiscal
stimulus, and about the deficit that came to dinner.
We can get to those questions in due course this morning, but I want to
begin by taking a slightly more long-run point of view and focus on the linked
issues of jobs and productivity, as Jim Tobin did. I hope in this way to avoid
the danger that is always present in discussions of any kind of policy, that we
redouble our efforts as we lose sight of the goal.
You will remember that during the 1980s — at least after the deep recession
of 1981 and 1982, which showed up on your charts, Mr. Chairman — the U.S.
economy was, in one important respect, the envy of Europe and much of the
world. Betvi^een 1982 and 1990, we generated 20 million payroll jobs in the
country. We even had the luxury of worrying that about 19 million of those 20
million jobs were in service-producing industries.
During that same period, the advanced economies of Europe experienced
only trivial increases in employment. Our euphoria about this contrast was
tempered by the observation that has again come up in your discussion, Mr.
Chairman, and in Jim Tobin's, that U.S. productivity, output per hour worked
in nonfarm business, rose by only 8 percent during that same long upswing.
Those two facts are connected by a piece of nonpartisan arithmetic.
The rate of growth of employment and the rate of growth of productivity
add up to the rate of growth of output. Given the path of productivity, we
could have had faster or slower growth of employment if we had managed
faster or slower growth of output.
15
It is natural in a discussion like that to think the productivity growth rate
was the given in the short run, although that is not quite true. That, too, came
up in Jim Tobin's remarks. We may now be seeing some of the dark side of
that earlier success in job growth.
Everyone is painfully aware that payroll employment today is still lower
than it was in 1990. Despite all the favorable straws in the wind in recent
months, the country has not yet managed a monthly increase in employment
large enough to cut into open and hidden unemployment. Even more omi-
nous is the continual stream of announcements of major layoffs at flagship
corporations like IBM, General Motors, United Technologies, Sears, and still
others.
In this context, it doesn't sound like good news that nonfarm business pro-
ductivity is up 4 percent in the past two years. Given that pace of productivity
growth, it would take a considerably faster increase in output to generate a
decent number of jobs. It almost looks as if all that job growth in the 1980s
may have been too careless to last. Businesses, including some of those large
businesses, may have added workers that they did not really need and the
competitive pressure to cut costs and eliminate uneconomic capacity is now
working in the opposite direction.
Any increase in productivity is a good thing when looked at from the cost
side. The labor shedding that we are seeing now, the squeezing out of workers
who are associated with capacity that can't earn its way or who are not reaUy
needed for the efficient operating of viable capacity, even that kind of labor
shedding is necessary and, in its way, useful. At least it tells us that we have
labor resources to use elsewhere in the economy if we can generate the de-
mand for the goods and services that they might produce if they were em-
ployed.
But labor shedding is a lot less promising for the long run than the produc-
tivity gains that come from the appearance of new capital and new technol-
ogy, and from productivity gains that themselves represent additions to
state-of-the-art capacity to produce. We would be better off in every run if we
were experiencing more of that kind of productivity increase.
Those questions are central to an evaluation of the current state of our
economy and the room it offers for expansionary fiscal and monetary policy,
and I think those questions are part or the thought behind thoughtful activ-
ism. We know that our economy is not using all of its capacity to produce, and
not employing enough of its available labor. The Federal Reserve's index of
capacity utilization in industry stands at about 79 percent, while it was above
84 percent in the first half of 1989.
To frame an overall policy, we need a notion of how much higher real GDP
could be this year and next without pushing up against the barriers that could
revive inflation.
Suppose we take 1988 as a reasonable benchmark, when the civilian unem-
ployment rate was 5. 5 percent. How fast has potential GDP been growing in
the last five years? I am referring now to one of Jim Tobin's diagrams. The
fact is that experts differ on the speed of the trend of potential GDP. Two
percent a year is on the low side of most of the expert's estimates and 2. 5 per-
cent a year is on the high side. Most of the model builders would settle for
something in between. If we proceed that way, the arithmetic suggests that
the current gap is about 4 percent of GDP, that is a little more conservative
76
than Jim's 5 percent figure. Even 4 percent would mean that we are about
$250 billion short of our potential production.
The history that I was sketching a minute ago suggests that there may be a
little extra uncertainty in these estimates, and the cushion may perhaps be a
trifle bigger than it looks, which would get me closer to Jim's ball park.
Now, what about the immediate future? How fast will potential GDP rise
in the year ahead? A pessimist would stick with 2 percent, an optimist might
be at or a tad below 2. 3 percent. I will opt for 2. 25 percent, recognizing that
all this smacks of more accuracy than anyone can hope for. If actual GDP
rose by 2. 25 percent during the four quarters of 1993, the gap between actual
and potential will still be 4 percent early in 1994 and the unemployment rate
would remain near 7. 1 percent. It would take faster growth in GDP to nar-
row the gap and reduce unemployment. Every increment of 1 percent in the
1993 growth rate eats up 1 percentage point of the initial gap and reduces the
unemployment rate by four- or five-tenths of a point. That is Okun's law that
Jim was describing. The best mainstream forecasters now expect real GDP
growth of 3. 2, 3. 4 percent in 1993. That is a litde higher than the blue-chip
average.
Most of them are busy, as we speak, shading those forecasts upward be-
cause the recent bits of news have been pretty good, although not overwhelm-
ing. It is important to realize that those forecasts already presuppose a small
stimulus package early this year, generally in the range of $15 to $20 billion. If
that story were to come true, you would be back here a year from now looking
at a GDP gap of almost 3 percent and an unemployment rate near 6. 5 per-
cent.
I suppose you could say that things were getting better, but as an experi-
enced grader of examinations, I will award only a gendeman's "C" to that kind
of performance.
There is enough slack in the economy to warrant a more aggressive ap-
proach. The payoff would be higher output, more jobs, with little danger that
inflationary pressure would return. It seems to me that 4 -plus-percent GDP
growth in 1993 is a fairly conservative target for policy. That would require a
stimulus package near $35 billion and an accommodating monetary policy
beside.
In that scenario, a year from now the gap between performance and poten-
tial would be cut nearly in half, perhaps 2 percent, and the unemployment
rate would probably be nearer 6 percent rather than 6. 5 percent.
I emphasize that this is a reasonably cautious approach. It would leave
some slack in the economy and give us something to think about for 1994.
There would be more room for the unemployment rate to come down. Of
course, having said that, I am an expansionist at heart. If the choice were
really mine, I would probably go for a bit more than I have recommended so
far. I don't really believe that an economic expansion is like a Popsicle, in the
sense that the slower you lick it, the longer it lasts. I think that there may be
more slack than the standard figures allow, but I am putting aside my natural
youthful aggressiveness and trying to be mature.
If I can take a minute or two more, I would like to say something about the
composition of a stimulus package. The general principle is that we should be
trying to favor investment at every turn, at the expense of consumption. An
investment tax credit for equipment should definitely figure in a package and
77
so should a permanent R&lD tax credit. We add effectiveness to a investment
tax credit if it were temporary, or at least had its rate tapering from a higher
temporary rate to a lower permanent rate.
I would vote for some productive infrastructure, but would not go hog wild
on what is rapidly becoming a buzz word. The goal should be to do those
things that enhance the productivity of private production. Most of those
things will involve maintenance, repair and the proper pricing of congested
facilities. Monuments are part of the problem, not part of the solution. My
hopes for faster growth of potential ride primarily on industrial equipment,
industrial R&D and a larger and more skilled labor force. Expenditures on
those items are almost sure to do good.
Timing is everjthing. The most effective time for stimulus is soon. The
sooner the economy picks up momentum and gets closer to capacity, the
sooner we return to reducing the budget deficit and provide domestic saving
for what we all hope will be a permanently higher rate of investment.
I want to make only two general points about the deficit reduction phase of
current policy. The first point is that the credibility of the program is far more
important than another $10 billion added to or subtracted from the target
deficit four or five years down the road. The deficit reduction part of the pro-
gram should be definite, detailed, concrete and specific about the taxes to be
increased and the expenditures to be cut, and when. It is hopeless if you are
seen as people saying, yes, dear.
The second point follows from the first. Once the Congress and the Ad-
ministration commit themselves to a path of deficit reduction, you will have
surrendered your ability to respond to macroeconomic surprises by making
short-run adjustments to macroeconomic policy. You will have lashed your-
selves to the mast like Ulysses and the Sirens, and for much the same reason.
Macroeconomic stabilization would then be in the hands of the Federal
Reserve. You should make damn sure that the Federal Reserve understands
and accepts its responsibilities for the economy. Treasury debt management
can help, as it can and should help now, by shortening the average maturity of
the debt, but the Fed would be the main player once you have committed
yourselves to deficit reduction.
[The prepared statement of Mr. Solow starts on p.llO of Submissions for
the Record:]
Representative Obey. Thank you.
Mr. Meltzer, please proceed.
STATEMENT OF ALLAN MELTZER, PROFESSOR OF POLITICAL
ECONOMY AND PUBLIC POLICY, CARNEGIE MELLON UNIVERSITY
Mr. Meltzer. Thank you, Mr. Chairman. It is a pleasure to appear again
before this Committee and contribute in a small way toward the important
societal choices that have to be made or will be made in the next few months.
The year 1993 has started out as an unusual year. The new Administration hit
the ground backpedaling. Senators Sarbanes and Sasser have become avid
monetarists, interested in all of the movements of M-2 growth, and I have
emerged as a defender of the Federal Reserve.
The economy continues to expand as we enter 1993. Your letter describes
the recovery as anemic. I would not use that term to describe recent perform-
ance. Preliminary data for the second half of last year show a growth rate of
78
3.75 percent, well above average growth for the U. S. economy and much bet-
ter than the average for the previous three years.
For 1992, as a whole, growth was slightly above the historical average of 2.8
percent, with only one quarter below the average rate. This performance
hardly justifies the mountains of paper that have been used to describe the
economy as stagnating or anemic, or to forecast second and third "dips" that,
we now know, did not occur.
Of course, the economy must grow at above average rates during recoveries
to compensate for falling output during recessions, so we should not be com-
placent about the recent record, but we should avoid additional short-term
stimulus based on faulty interpretations. PoUcy in 1993 should concentrate on
encouraging sustained growth and productivity in order to continue the very
promising improvement in productivity achieved during this recovery to the
present time.
There are at least four reasons why the recovery has been slower than the
postwar average. First, many of the earlier, more rapid cyclical expansions laid
the seeds of future inflation followed by disinflation and recession. The main
reason: excessive money growth in the early quarters of recovery later spilled
over into inflation.
Second, mild recessions are typically followed by slow recovery. Despite
many fanciful allusions to the Great Depression, the 1991 recession was one
of the postwar era's mildest; hence, the recovery should have been expected
to be and has been mild.
Third, the recovery has labored against sizable defense cutbacks. It has not
been possible to beat swords, tanks and airplanes into plowshares or machine
tools without making sparks. The worst performance in this recovery is con-
centrated in California and in the Northeast where defense industries and
electronics have reduced employment much faster than peacetime jobs have
been created.
Fourth, falling real estate prices have been a problem for banks from Aus-
tralia and Japan to Britain and the United States. The Fed met this challenge
with moderate monetary expansion that lowered interest rates, but did not
reflate real estate prices. Lower interest rates improved banks' profitability,
probably sparing us the cost of a bank bailout, and let many property owners
refinance with lower carrying costs.
Avoiding reflation preserved the benefits of lower inflation and encouraged
the cuts in long-term interest rates that are essential to the transition to lower
inflation. These reductions in long-term rates have continued in 1993. There
are costs to a slow recovery but, so far, the costs have been small and there
are some offsetting benefits.
The long-term benefit of a cutback in defense spending is the resources
released for private use.
It is too soon to know whether slow growth of consumer spending during
this recovery indicates transition to a higher average saving rate or is a tempo-
rary change. Slow inflation has many benefits. The rate of wage increase is
now aligned with productivity growth. Unit labor costs for U. S. industry have
fallen relative to foreign competition so that exports have continued to grow
at an 8 percent rate despite recessions in many overseas economies.
Lower inflation reduces the tax on durable capital that results from the fail-
ure to index depreciation allowances. If low inflation is sustained, it will be a
79
lasting benefit for capital intensive industries. It is beyond logic to suggest that
the government should offer firms an investment tax credit while raising the
hidden tax on capital by increasing future inflation.
The best available evidence suggests that long-term growth is not changed
by the slow pace of recovery. The difference between the recent 2.75 or 3.75
percent over the last six months and a more rapid 4 percent or 5 percent re-
covery will be made up in future years. A durable recovery and prolonged ex-
pansion is important for making up the substantial difference.
Future income is not equivalent to current income of course, so there is a
cost of slow recovery; but the cost is only a small fraction of the difference
between 2.75 percent and 4 percent growth for a year or two, and if inflation
continues to ciecline the loss will be compensated, in whole or in part, by the
benefits of lower inflation. And low inflation will extend to years of expansion.
Some critics of the Fed and some members of this Committee have been
critical of the slow growth of a particular broad measure of money known as
M-2. In the past M-2 growth has been a reliable indicator of long-term growth
of nominal GDP. There is no reason to believe this long-term relationship has
changed. However, the short-term relationship between the growth of M-2
and the growth of nominal GNP has always been subject to relatively large
departure from a long-term relation.
Forecasts of near-term spending, based on M-2, have often been subject to
relatively large errors. The same is true of the more complex interactions in
large scale computer models containing hundreds of equations. Indeed, all
short-term economic relations are subject to large errors.
Few forecasters predicted the jump in GDP growth in the second half of
last year. Until November, some were still revising downward their forecasts
and predicting a return to recession in the fourth quarter. It would be a mis-
take to give credence to the cacophony from these croaking Cassandras.
We should choose policies that promote sustained growth with low infla-
tion, not short-term recovery at the expense of future growth.
Other measures of money do not show the same pattern as M-2. Money
issued by the Federal Reserve is called the monetary base. The monetary base
consists of the reserves that bank holds and the currency that we all use.
Every stimulative action to increase money and credit increases the amount of
monetary base outstanding. And when the Federal Reserve reduces the mone-
tary base, measures of money and credit fall.
The base and all measures of money include holdings of U. S. currency by
foreigners. Much of this currency is held outside the United States. It is not
used for domestic spending and it does not affect U. S. GDP.
A chart in my prepared statement shows the relation between the growth
rate of spending, GDP, and the growth of domestic monetary base — the
monetary base net of estimated holdings of U. S. currency. These estimates
were prepared by researchers at the Federal Reserve Board.
The chart compares the growth of spending at annual rates in a given quar-
ter to the annual growth of the domestic base for the period ending six quar-
ters earlier. That is, there is a six quarter lead of base money before the
turning points in GDP.
As you will see from looking at the chart, it shows that all of the recent
turning points in money growth with a six quarter lead have predicted the
turning points in GDP growth after the 6 quarters have elapsed. This
80
correspondence is close for the period since 1985 and suggests that monetary
growth has been important over this period in producing the recovery that
began in 1991.
Like all such relations, this one is subject to change. If the relation holds,
growth of the domestic pace predicts the growth of spending in 1993. I read
the chart as saying that contrary to the current critics, the Fed eased money
throughout the current recovery. There is now substantial monetary stimulus.
The message for the future is the continued growth of the domestic base at
recent rates will be adequate to sustain recovery and will raise inflation per-
haps by 1994. Now is the time to stabilize the economy and prevent that in-
crease. Prudence calls for about 2 percent less growth of the domestic
monetary base than the average of the last two years. This would lock in the
gains against inflation brought about by the tight monetary policy from 1989
to 1991 and contribute to a durable expansion with low inflation. It would
avoid repeating the counterproductive policies of the 1970s that led us from
boom to inflation to bust.
Productivity growth in 1992, 3 percent from fourth quarter 1991 to fourth
quarter 1992 was the largest increase in 20 years. That takes us back to 1973
when your charts show that productivity entered its period of slow growth. In
manufacturing, reported productivity growth has shown improvement for al-
most a decade, but service-sector productivity has not.
Recent estimates suggest that after falling through the 1970s and the 1980s,
service-sector productivity has shown a sustained increase since early 1990.
Service-sector output per private service job — a broad measure of service-
sector productivity — reached a peak in 1976, declined until first quarter of
1990, and has now advanced 5V4 percent from that base to recover in 2V4
years, almost the entire decline of the previous 13 years.
The recovery of service -sector productivity growth is very welcome. Produc-
tivity growth is the necessary condition for sustained growth of real incomes
and living standards.
Productivity growth not only raises standards of living, but the historical
record suggested to Simon Kuznets earlier, as it has to me recendy, that over
long periods economic growth narrows the spread of the income distribution
about which you commented. Everyone gains from growth, but low-income
earners gain relatively more, so income differences narrow slowly but steadily.
The opposite side of the increased productivity growth is the slow growth of
employment during the recovery to date. When combined with a loss of jobs
in the defense and defense related industries, we get below average growth in
employment and the highest unemployment rates concentrated in those states
with largest defense-related activities.
For 1992, the average unemployment in the ten states with heaviest con-
centration of defense spending was considerably higher, more than a few per-
centage points higher than unemployment in the other 40 States.
Much current discussion suggests that the most urgent necessity is to re-
duce the deficit while increasing spending to provide short-term stimulus. I do
not share that view. The recovery will continue without additional short-term
stimulus. The reported deficit is poorly measured and overstated. The budget
deficit is not as much of a problem as is widely repeated.
More important and deserving of more attention is how the money is spent,
how resources are used, and how the deficit is financed. If we, as a nation,
81
had incurred the same deficits but used all the borrowed money for produc-
tive investment in human and physical capital, we would be much richer and
would have higher living standards. The economy would generate revenues
sufficient to reduce debt in the future.
Public policy has discouraged investment in several ways. Depreciation is
not indexed so inflation is a tax on invested capital, particularly long-lived du-
rable capital. The 1986 Tax Act shifted taxes from consumers to owners of
capital. Earned income including saving is taxed, and is almost certain to be
taxed at higher rates beginning this year.
Taxing saving is not a way to encourage growth and raise living standards.
Taxes should be shifted from earned income to consumed income. This could
be done most readily by allowing taxpayers to subtract their annual saving
from adjusted gross income and levying the tax on the remainder-spending or
consumed income. This change would increase saving. Corporations should
be allowed to uTite off all or most of their purchases of machiner>' and equip-
ment. This would increase productive investment and productivity.
Encourage general research and development and improvements in the
quality of education and training by promoting competition in schooling and
by increasing incentives for learning. In many countries, school grades and
performance are important for getting a first job. This encourages effort and
learning. This is not true in the United States.
I am told that one reason is that our laws would treat such information as
evidence of discriminatory action on the part of employers.
Avoid the drift into protectionist policies and reverse the quotas and so-
called voluntary restraints that burden consumers, lower living standards, re-
duce competition and threaten the world trading system.
The United States has led the world through nearly 50 years of growth. The
most-favored-nation principle that started in the U. S. Congress, and multilat-
eral tariff reduction led by the United States, were major forces producing this
achievement.
Now, many in this same Congress want to turn back toward protectionist
policies that are costly to us and destructive of the rules of open trade. They
urge policies that are inimical to growth and that lower living standards here
and else where.
Much of the U.S. economy is in a strong competitive position. Unit labor
costs in many industries have fallen far below comparable costs abroad. This is
the time to benefit our own economy by adopting rules for freer and more
open trade and by strengthening enforcement through GATT.
Lower payroll taxes would encourage employment. A higher minimum
wage and more mandated benefits raise the cost of employing labor and re-
duce employment.
Avoid the temptation to develop an industrial policy. The private sector is
not always right, and the public sector is not always viTong. What matters is
the batting average over years or decades. Be happy that you did not subsi-
dize investment in the supersonic transport, HDTV, the fifth generation com-
puter, and many other well -advertised projects that were at one time or
another claimed to be critical for our prosperity or even our survival.
Beware of the Marxist fallacy pushed by proponents of protectionist poli-
cies and industrial policy that progress is limited to the so-called leading sec-
tors. That isn't true.
82
The policies I urge on you are policies for growth and higher living stan-
dards, not short-term stimulus. If you remove barriers to trade, avoid cosdy
and burdensome regulation of commerce and industry, encourage improve-
ments in the quality of education for all, reduce taxes on saving and invest-
ment and insist that the Federal Reserve maintain the near price stability that
is now ours, growth and living standards will continue to rise as they have
throughout our history and jobs will increase and continue to expand, as they
always have.
Thank you.
[The prepared statement of Mr. Meltzer starts on p. 113 of Submissions for
the Record:]
Representative Obey. Thank you very much.
Let me start by observing that after I watched President Clinton's town
meeting last night, I then had the great pleasure to watch Congressman Newt
Gingrich respond to the President. And that noted Nobel Laureate, Mr. Gin-
grich, indicated that, in his view, we were going to have a recession sometime
in the next two years. And he indicated that we had to remember that we
were going to be losing several hundred thousand jobs because of continued
builddown of the defense budget, and he also indicated that we had over
300,000 jobs or we had already had, announced by companies, future plans to
lay off 300,000 people.
Given that caution by Mr. Gingrich, I guess I am a little surprised that the
Republican Party line appears to be that we should not buy a litde insurance
by providing the kind of stimulus package that Mr. Solow and Mr. Tobin are
urging this morning.
I want to pick up, Mr. Tobin, on something that you said when you talked
about the difference between layoffs in previous recessions and this recession.
This chart, I think, emphasizes again the point that you made earlier. What
this chart demonstrates is that if you take a look at past recessions of 1975,
1981-82 — you see that represented by the gray — we had significant increases
in temporary layoffs. A large peak here, a large peak here; those accompanied
large increases in permanent separation. But if you take a look at what has
happened the last year-and-a-half, from this point on the chart, you see that,
in fact, from 1983 on, temporary layoffs remained fairly stable.
But you have had a large amount of those layoffs being permanent and, in
fact, since 1990 we have had a very much larger share of the layoffs being per-
manent layoffs. And that seems to me to bear out your contention that we
need to recognize that in some ways, including that one, this unemployment is
more severe than the raw numbers would indicate. It would also indicate to
me that we have not had such a high share of the unemployment, which was
represented by permanent layoffs except in the most serious recessions, which
we have had in the postwar period.
Let me ask a couple of questions, and ask Senator Sarbanes for his com-
ments and questions.
I think one of the jobs we are going to have as we proceed down the road
that you are talking about with a modest stimulus package, we are going to
have to explain to the public in very clear terms why it is that in the middle of
an effort to reduce the deficit, long term, we are still trying to do something
which might appear on the surface to be contradictory by also providing a
short-term stimulus package.
83
Tell me, if you would, what we ought to tell our constituents when they ask
us whether that is not, in fact, inconsistent, Mr. Tobin and Mr. Solow, since
you are the two prescribing that medicine.
Mr. Tobin. I think what the proper medicine is for the patient depends on
the circumstances of the patient and what the disease is. So it is not appropri-
ate to give this economy a dose of deficit reduction medicine, which is going
to reduce demand for goods and services and the jobs related to those de-
mands, at a time when the economy is weak and barely coming out of this
long period of stagnation since the so-called "trough" in 1991 first quarter.
When the economy is robust, when we have got unemployment and excess
capacity back down to normal peacetime prosperity rates, then the economy
can absorb deficit reduction. In those circumstances, it will still be necessary
for the Federal Reserve to make the adjustments of monetary policy that
make up for the restriction of demand by fiscal policy.
I admit that this is a subtle point and hard to get across to reporters, pun-
dits, columnists and talking heads. Maybe it is sometimes hard to get across to
Congress and even to our students. But the problems are there, so we have to
do our best to explain them.
Representative Obey. Mr. Solow?
Mr. Solow. I am tempted to adopt a medical analogy, which probably ex-
plains why medical costs are so high. I am of an age where a certain number
of my friends are having surgery every year and it is not unknown for them to
have to be built up to a degree of health where they can withstand surgery.
Deficit reduction will be contractionary for the economy. That is why the
Fed is needed to take up some of that slack. It would be a terrible mistake, I
think, to impose that necessary contractionary force at a time when the econ-
omy is just struggling to emerge from what has not been a very deep recession,
but has not been a typical recession either. It has lasted a long time. Natural
recovery from it is slow.
"We are looking at a chart that suggests the private economy is finding it
very difficult to generate permanent jobs. The important thing is to commit
the patient to that surgery and then to build him or her up to health where the
surgery can be withstood.
Mr. Meltzer. May I point out that the same arguments, if you accept
them, which apply to spending increases must apply just as logically to tax rate
increases. If you accept the argument, you should not be in favor of the Presi-
dent's program to increase tax rates on corporations, if that is what comes
about, and tax rates on individuals in order to cut the deficit. They would be
counterstimulus measures also.
Representative Obey. I would grant that, but I think that we should not
assume timing with respect to the President's tax suggestions. So far as I
know, the President is not proposing any significant tax increases which would
go into effect immediately, which I will grant would have a contractionary ef-
fect on the economy.
It seems to me, gendemen, what you are saying is that unless we buUd up
enough momentum in the economy first, efforts to achieve deficit reduction
might in fact not succeed. We might in fact run into a situation such as we did
in 1980 when efforts were made to cut the deficit, but because of the econ-
omy sag the deficit in fact grew larger no matter what the political pronounce-
84
ments of people in the White House encompassed about their intention of
cutting the deficit.
Mr. Solow. You would be in danger of giving Mr. Gingrich the recession
he is hoping for.
Representative Obey. Let me ask, Mr. Meltzer, I would like you to expand
on your comments in your statement, and let me quote exactly so that I don't
misstate what you said:
The reported deficit is poorly measured and overstated. The budget defi-
cit is not as much of a problem as is widely repeated.
Would you elaborate on that, please?
Mr. Meltzer. First, as far as measurement, there are lots of problems about
how deficits get measured. The current measures of the deficit include things
like the costs of the S&L bailout. These costs have no economic burden at all.
The burdens incurred were incurred when resources were used badly or
wasted back in the 1980s, or earlier. When the deficit was increased by trans-
ferring these expenditures onto the deficit, losses which had been on the
books of various thrift agencies, the savings and loans, were replaced by
bonds, and this became part of the measured deficit. So that part is not an
important part.
The interest payments on the deficit are rather neutral in their economic
effects, and a good part of the deficit is made up of interest payments. For
those reasons, many economists concentrate on what is known as the "primary
deficit" — that is, the deficit net of S&Ls.
Those are some of the reasons why I say this measure does not adequately
represent what it purports to measure. There are a lot of other reasons that
would occupy more time and perhaps try your patience more than is neces-
sary.
Second, what is important is how we use resources. What gets crowded out
in most discussions of the deficit is how we use the resources. If we had bor-
rowed that money and invested it productively in human or physical capital,
we would be receiving returns.
Our problem as a nation is to shift some of our resources away from spend-
ing for consumption and onto spending for investment, both public and pri-
vate, particularly in areas like education and development of physical capital.
With the same deficit, short term, and greater investment at the expense of
consumption and more savings, the economy would grow faster, produce
more, earn better, and have some resources available to retire the deficit in
the future.
Representative Obey. Well, it sounds to me as though that, at least in part,
reinforces something which was in Mr. Tobin's statement, indicating that
there is a very different economic result in the kind of deficits which were in-
curred in the 1980s when those deficits were used to finance a large run-up of
mihtary expenditures and tax reductions, which were not necessarily put into
productive enterprises, versus the kind of investments which the President has
been talking about by way of stimulating business capital investment and by
way of increasing education, training and infrastructure efforts.
Mr. Meltzer. The use of resources is very important. I would add that the
money that was spent on the defense buildup in the 1980s is now, of course,
permitting us the opportunity to reduce the military spending in the 1990s.
That is a good part
85
Representative Obey. I don't want to get into a debate about whether it
was a good idea to raise defense spending. I am trying to make the point that
that was not the most economically productive way that you could have —
Mr. Meltzer. Yes. I am trying to be agreeable.
Mr. Tobin. I agree with what Allan said and what you said. It is important,
though, if you make a shift away from consumption into higher saving, say in
1995, when we have an economy that is robust enough to stand higher taxa-
tion, to make sure that the monetary policy is going to cooperate, that interest
rates will be low enough so that the resources released from collective or per-
sonal consumption are in fact channeled into productive investment and not
wasted in unemployment and excess capacity. That is very important. It is not
something that happens automatically, in my opinion. It is something that re-
quires a cooperative monetary policy.
In line with what you were just saying, deficits for public facilities, for pub-
lic investment, for education, which wiD increase productivity and real wages
in the long run, should not be regarded the same as deficits for consumption.
I hope the President will not be apologetic about deficits that are run for the
good purposes that he advocated so strongly during his campaign.
Representative Obey. Thank you. Let me just ask one more question on
the deficit. I have an instinct on this; I suppose it is a bias, but I would like to
know whether you share it or not.
Right now, my instinct is that most people in the press, when they talk
about the deficit, have a picture in their mind of this chart showing that the
nominal dollar level of that deficit has exploded since 1980, and they want to
see this come down, or at least it is easier for them to understand what is hap-
pening if you talk about the deficit in terms of reducing it by specific dollar
amounts. The problem with that is that, as this chart indicates, during the
1981-84 perioci, while the country was promised that the deficit would per-
form in a very exact fashion, as represented by the green bars — this was sup-
posed to be the path by which the deficit got down to zero if we listened to
the Reagan plan — because even presidents cannot command the economy to
do specific things; they don't have that power — the deficits in fact rose by very
large amounts during that period.
That leads me to this conclusion. I wonder if you would comment on it. It
seems to me that it is crucial, if we are to win public support for whatever the
President proposes, that it have a serious long-term deficit reduction compo-
nent, but that it be looked at in the right context. And it seems to me that this
demonstrates the right context. The crucial issue is whether or not we can re-
turn to the trend line which we were following between 1946 and 1973, stall-
ing out between 1973 and 1980, of reducing our debt as a percentage of our
income over time in a very determined manner. If we can produce a package
which will tip this line, which is now going up and is expected to go up even
more rapidly, if we can begin to curve that line down again over a sustained
10-year period so that it is clearly, over the remainder of this century, resum-
ing this downward path, that that is a much more important question than
whether we hit $145 billion in deficit reduction the fourth year, $120 billion or
$160 billion in that that is the way the President's efforts ought to be evalu-
ated.
I would like your comments on that.
86
Mr. Solow. This is another one of those complicated questions, and I think
that it is unwise to limit yourself to one way of describing the problem and the
solution and the outcome of whatever is proposed.
It is certainly right that whenever you can scale debt and deficit magnitudes
by the GDP, by the size of the economy, you will no doubt cause an extra eye
or two to glaze over, but you will be giving a more accurate representation of
what is going on. In describing what you expect to happen to the budget defi-
cit in view of policies adopted, I think there is nothing for it but to talk in
terms of the structural deficit as a fraction of GDP because that is what mat-
ters, and finding ways that sound simpler only obscures the issue.
I think, looking at what legislation is expected to do to the standardized or
normalized, or high employment, or structural budget deficit as a fraction of
GDP, is one line of argument. I think the picture that is now on the easel is
another important line of argument, and I would not abandon that. I would
caution you, though, that that curve responds very slowly to anything that you
do now. So, again, you run the risk of exceeding the attention span of the lis-
tener by describing what is a complicated problem. And I would not give up. I
would talk about that. I would talk about the deficit. I would just do it in the
right way and in a logical way.
Representative Obey. One last question, and then I will ask Senator Sar-
banes to comment.
You indicated, Mr. Solow, that you thought it would be far preferable and
a far better economic effect if the investment tax credit, if it is proposed by
the President, would be temporary. Would you elaborate on that?
Mr. Solow. Yes, sir. One can argue as to whether there is good social rea-
son for having an investment tax credit permanently or not. What is beyond
dispute, I think, is that any temporary part of an investment tax
credit — whether all or only a fraction of it — exercises a very powerful incen-
tive for businesses to shift investments through time. And an investment tax
credit that goes away at the end of 1994 or on July 1, 1994, or something like
that, will certainly attract a lot of investment into the interval between now
and then, and it will subtract some of it from the interval after.
Well, the economy does not move regularly. Allan is more inclined than I
am to forget about those short-run fluctuations. I think of them as mattering
and mattering a lot. If it is desirable for the general health of the economy to
fill in those troughs we talked about, then temporary tax reductions, tax re-
ductions like an investment tax credit that give you a reward for something
that you do now and then take the reward away, gradually or totally, some-
time in the future, will certainly have a more powerful effect than one that
doesn't have that aspect.
Mr. Meltzer. On the opposite side, your chart on productivity growth was
very revealing of the longer term problems that were put up in other charts —
why wages are not growing. Wages can't grow on a permanent basis unless
productivity grows. But the economy needs permanently more investment in
physical and human capital. The way to get that is to make these changes long
term, to try to solve now, going into the 1990s and the next century, the long-
term problems we have had for the last few years of not having high produc-
tivity growth. I see no great advantage in putting more investment into 1994
at the expense of 1995. That is not a direction that will solve the problem.
87
Put yourself in the position of a businessman in December 1994, who
knows that credit is going to expire January 1. He is going to put a lot of in-
vestment into December and November and October, but that is not going to
do much to raise the average rate of investment in the economy over a long
period of time. And that is what I believe the productivity chart, compensa-
tion chart, wage chart, and a lot of the others that you showed, including the
distribution of income chart, I think those are things that you want to concen-
trate on.
Mr. Solow. It is sometimes necessary to walk and chew gum at the same
time. It is possible for a society to have two objectives. One may be a higher
rate of investment in the long run. I think that is absolutely fundamental and
important.
On the other hand, the economy does fluctuate in ways that are not pro-
ductive, that cause numbers of people to be unemployed and cause businesses
to lose profits. To the extent that it is possible to smooth those fluctuations,
that won't do much for the longer term rate of growth, but it will smooth the
fluctuations. It will not sacrifice long-term investment. I will go as far as any-
one in trying to promote long-term investment. I see no reason to take the
high and mighty view that as a tenured professor in a great university, I can
afford to ignore two- and three-year fluctuations in output.
Representative Obey. Senator Sarbanes.
Senator Sarbanes. Thank you very much, Mr. Chairman. I want to com-
mend you for scheduling these hearings. I think they are very important, and I
am pleased that I have the opportunity to participate in them here this morn-
ing and again this afternoon. I apologize for not being here to hear your open-
ing statement. I have looked over your charts and can appreciate from them
that it was a very strong outline of our situation.
Mr. Chairman, I do want to say one thing at the outset. I have been called
a lot of things in my day — and I don't mind that — but I have never been
called a monetarist before.
Mr. Meltzer, if you are going to call me names, I think you ought to wait
until I get into the room before you start doing it.
I want to pick up on one last point that was made, and then I will lead into
my line of questioning. I think the challenge-and Professor Solow picked up
on it very well in response to Professor Meltzer-is to harmonize what we do in
the short term with what we want to do in the long term. I think it is ludicrous
to pretend that the short term won't impact on the long term. If the short-
term downcycle is too great, it is going to have a lot of implications for what
happens over the long term. It is going to impede our abifity to swing into a
long-term program.
I think President Clinton is very sensitive to that. He has been very em-
phatic in trying to make the point that what he wants to do is to address the
short-term problems along the same track with what we need to do to address
the long-term problems, to the extent that is possible. And I think it is possi-
ble to a large extent, and I think it is one of the challenges that is now before
us.
I want to talk a little bit about the jobs recession that we are in, and I par-
ticularly want to get at the point of the extraordinary contrast between this
recovery and previous postwar recoveries. I think it is absolutely essential to
try to lay that out. Of course, what this chart shows, this line, is the growth.
88
the average of the previous recession recoveries and jobs, the restoration of
jobs coming out of the trough. (See chart below). This is what we are experi-
encing in this recession recovery cycle. It shows a dramatic contrast in recover-
ing jobs in previous recessions. By this many months after the trough of the
recession, we not only had recovered all the jobs that had been lost — here is
where we were when we started down — but went well beyond that to recover
many more jobs, to have some real job restoration.
In this recession, we are tailing along here. We have recovered maybe 30
percent of the jobs that have been lost. In the previous recoveries, we have
ranged anywhere from 160 percent to 400 percent, depending on which reces-
sion you are talking about. But in all of them, at this point we have come back
and picked up all the jobs.
We have not done that this time, and we continue to face a serious unem-
ployment problem. Unemployment is higher now than it was at the trough,
which was quite some time ago. We have never had an unemployment rate
which, at this point after the trough, was higher than it was going into the
trough.
The first question I want to put to you, it is my own view that the combina-
tion of fiscal and monetary policy in this recession recovery cycle has been far
less stimulative than in any of the other previous postwar recessions. Would
anyone disagree with that?
Mr. Meltzer. I would.
Senator Sarbanes. What is the basis of your disagreement?
Mr. Meltzer. If you look at my paper, you will see a chart showing changes
in monetary growth measured as the growth of the domestic component of
the monetary base compared to GDP. I have the chart here.
Senator Sarbanes. Is this the chart?
Mr. Meltzer. Yes.
Senator Sarbanes. That chart is trying to make your point that you think
monetary policy has been more expansionary in this recession recovery period
than a lot of us think.
Mr. Meltzer. Adequate expansion in this period; that is correct.
Senator Sarbanes. Has it been more expansionary than in previous reces-
sion recoveries?
Mr. Meltzer. It has avoided the problem of too much expansion.
Senator Sarbanes. That wasn't my question. Has there been more expan-
sionary monetary policy than in previous postwar recession recoveries?
Mr. Meltzer. It has been as expansive as on the average of many postwar
expansions.
Senator Sarbanes. How about fiscal policy? Has that been more expansive
in this recession recovery period than in previous recessions and recoveries?
Mr. Meltzer. If you measure fiscal policy by the size of the deficit, it cer-
tainly has been highly expansive.
Senator Sarbanes. Is that how you measure
Mr. Meltzer. That is one way in which people measure the size
Senator Sarbanes. Is that how you measure it? That is how some members
of the Congress measure it, many of whom don't understand the relationship
between a deficit that results from a slow economy, as opposed to a deficit
89
that is intended to avoid a slow economy, as opposed to a deficit that is in-
tended to avoid it. Do you measure it that way?
Mr. Meltzer. Not typically.
Senator Sarbanes. Given that you don't, do you regard fiscal policy in this
recession recovery period as more expansive than the previous recession re-
covery periods?
Mr. Meltzer. Growth in government spending, which is a good measure of
fiscal expansion, has been relatively strong, particularly in light of the cutbacks
in defense spending.
Mr. Tobix. I think the proper way
Senator Sarbanes. Mr. Meltzer, I am having a lot of trouble uith your an-
swer. You throw this chart at me to make the point that you think monetary
policy is more expansive currently than a lot of us think it is. Then, under
questioning, you say, well, in comparison with previous recession recoveries,
on monetary policy alone, it is as expansive.
Mr. Meltzer. That is correct.
Se.nator Sarbanes. And fiscal policy, I would assert, has been less expan-
sive. So, if you take them in their totality, I think the stimulative impact of
fiscal monetary poHcy combined in this recession, which is the way I put the
question, has been less expansive.
Professor Tobin?
Mr. Tobln. I think the proper way to measure fiscal policy approximately is
to look at the change in the noncyclical or structural deficit of the budget
— not the absolute amount, but the change in it that has occurred because of
acts of tax and expenditure legislation. Tne point is to eliminate the endoge-
nous cyclical part — the changes that occur as a result of a response to the eco-
nomic circumstances.
On that basis, it surely is true that there has been no fiscal policy stimulus
in this particular business cycle. In that respect, it is almost unique. The
much-touted 1980s recovery had the benefit the largest fiscal stimulus of any
peacetime recovery in our history. I don't mean just in dollars but in structural
changes of the deficit as a percentage of GNP.
That recovery was driven by a big fiscal expansion, so big that the Federal
Reserve didn't have to do anything but decide how to let up on the monetary
brakes, how much they could allow interest rates to come down. The Fed did
not have to be extremely active. They didn't want deficit spending to overheat
the economy, but they didn't want to offset it too severely either.
In this business cycle, I think it is misleading to look at the monetary plus
fiscal stimulus in terms of the ordinary timing of business cycle peaks and
troughs. Actually, if you measure relative to the potential GNP track, we were
in a recession since the first quarter of 1989, and during all that time, as Al-
lan's own graph shows, the monetary base growth was declining.
I don't particularly like to look at monetary policy in terms of M-zero any
more than I like to look at it in terms of M-one or M-two or M-nine. But
those measures confirm, I think, the conclusion I reach by looking at interest
rates, that the Federal Reserve reacted very slowly, very late, and almost al-
ways too little. The Fed let the economy get out of their grasp. As a result, we
need more fiscal policy to get out of this box than we would have if the Fed
had acted more decisively and earlier.
90
Senator Sarbanes. Professor Solow?
Mr. Solow. I just want to add two brief points. I think Jim has covered the
essentials.
On fiscal policy, it is certainly improper to look at federal spending net of
defense spending and say, oh, well, if there hadn't been a reduction in defense
spending, we would have a better looking fiscal policy. We sure would. But
we did have a reduction in defense spending, and a sensible fiscal policy
would have replaced that by some other fiscal stimulus.
The second thing I would like to point out
Senator Sarbanes. It is reminiscent of the 1980s when we ran defense
spending way up, and everyone said government spending is not going up. It
was as though defense was something separate and apart from government
spending.
Mr. Solow. The second point I would like to make. Senator, is that, as a
relatively recent monetarist, you are perhaps not fuUy acquainted with all the
t\xasts and turns of monetarists' doctrine, but there are other longer term
Senator Sarbanes. I don't want to get in that box because I don't want to
have to try to become acquainted with the twists and turns. I am anxious to
stay out of that box.
Mr. Meltzer. May I add
Senator Sarbanes. We are going to let Professor Solow finish. Then we are
going to come to you. Obviously, you want a chance to respond. We will give
it to you in just a moment.
Mr. Solow. I am about as much of a monetarist as you are. Senator Sar-
banes, but there are respectable people with a long, respectable history of
monetarism, Milton Friedman and David Fand, who concluded from their
own interpretation of the entrails that in fact the Federal Reserve did not offer
any genuine support for the economy, but followed the economy down pas-
sively.
Mr. Meltzer. Senator, let me just give you the figures. It is called into
question about federal nondefense expenditures. Let me give you the figures
from the National Income Account Budget. Between the third quarter of
1990 and the third quarter of 1991, National Income Account total expendi-
tures increased by $83 billion. Between 1990, the third quarter of 1991, third
quarter of 1992, which is the last figure I have here, it increased by $111 bil-
lion.
Senator Sarbanes. Does not include unemployment insurance?
Mr. Meltzer. It includes all expenditures which appear on the National
Income Account.
Senator Sarbanes. I want to be clear. Would unemployment
Mr. Meltzer. Yes, it includes unemployment.
Senator Sarbanes. An increase in unemployment insurance, as a conse-
quence of the slow economy, would be reflected in those figures you are giv-
ing me; is that correct?
Mr. Meltzer. That is correct. We could take the cyclically adjusted budget
deficit — unfortunately, they are not available for the whole period — but that
also has been rising for the period of the recession itself. The last figure I have
here is through the second quarter of 1991. That number was also rising.
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For example, it rose by approximately $26 billion from second quarter of
1990 to second quarter of 1991, but the unemployment surely doesn't make
up for the bulk of the $111 billion of increase in National Account spending.
That is 8 percent of the budget. That is, it is an 8 percent growth rate of the
base budget, so that is a relatively expansive fiscal policy, as I would measure
fiscal policy, looking at the growth of total expenditure.
Offsetting that, of course, is what is happening to receipts on the National
Account budget, but those receipts over the same period, when we had an
$111 billion increase in expenditure, increased by $28 billion. So the net of
that was an expansive federal program. How it compares to other periods I
don't happen to carry in my head.
Senator Sarbanes. Less relevant to the question that I put out.
Mr. Meltzer. Yes, it is.
Senator Sarbanes. Now, Milton Friedman said on October 23 in the Wall
Street journal:
The Fed's inflation objective is close to being achieved. Indeed, the Fed
is temporarily overshocked. Continuation of M-2 growth at 2 percent
per year would imply actual deflation, not negligible inflation. Given its
depanure from its own policy, the Fed now needs to speed up sharply
monetary' growth to bring M-2 back to its target range and then hold it
there.
I take it you disagree with that, Professor Meltzer?
Mr. Meltzer. And the facts have not borne that out, of course. Let me say,
Senator, that we complained a lot about the tight Federal Reserve policy from
1989 to 1991 when the monetary base for foreign currency, adjusted or unad-
justed, was declining. We forecasted a relatively good expansion for the sec-
ond half of this year, and that has come about.
Now, I don't want to put a lot of weight on forecasts because I don't be-
lieve that forecasts — mine or other people's — are very accurate. What we are
talking about now, in much of this discussion, is whether there is a great reli-
able forecasting mechanism available in the monetary aggregates or in any
other measure. It would be nice if that were true. Unfortunately, it is not true,
so one should not put a great deal of weight on future forecasts. Nevertheless,
the base growth has done rather well in forecasting what has happened over
the last half a decade or more.
Senator Sarbanes. So you disagree with Professor Friedman?
Mr. Meltzer. Indeed.
Senator Sarbanes. Do you think the money growth has continued through
1992?
Mr. Meltzer. Yes, it has continued.
Senator Sarbanes. It hasn't slowed?
Mr. Meltzer. No. My chart shows that it has been about constant at an
average rate of somewhere between 7 and 8 percent.
Se.nator Sarbanes. Do you think inflation has risen in 1992?
Mr. Meltzer. No. It has declined.
Senator Sarbanes. It has declined?
Mr. Meltzer. Yes.
Senator Sarbanes. On February 2, 1992, you wrote a column, "Why the
Federal Reserve's Discount Rate Cut Will Bring on Inflation."
76-207 0-94—4
92
Mr. Meltzer. I think that is-
Senator Sarbanes. That is the heading of the column.
Mr. Meltzer. I don't write the headlines.
Senator Sarbanes. You say in the article, "unless money growth slows soon,
inflation will rise."
Mr. Meltzer. Yes.
Senator Sarbanes. Now, you have just told me that money growth did not
slow
Mr. Meltzer. That is right.
Senator Sarbanes. and inflation did not rise.
Mr. Meltzer. Yes. My forecast
Senator Sarbanes. It wasn't a very accurate prediction, was it?
Mr. Meltzer. No, it was not an accurate prediction. I do not make any
claim to being more accurate in my predictions than Professor Friedman or
other people are in theirs.
Senator Sarbanes. It all comes back to the comment Professor Solow
made about being a tenured professor.
Mr. Meltzer. I don't think so, Senator.
Senator Sarbanes. Which means he has a job. Because, you see, you make
these predictions and they don't work. I mean, your job continues, you know?
But what we are concerned about are these people out there who are unem-
ployed and can't get a job. We are concerned about this job
Mr. Meltzer. And I am concerned about them too. Senator.
Senator Sarbanes. Well, I cannot
Mr. Meltzer. But I also think that the other side of that chart is the chart
which would show productivity growth. It is important to take account of the
fact that the people who are working are working at higher productivity and
that is good for their long-term prospects. As I emphasized in my statement,
what is important here is that we put these people back to work, not just to
get them back to work, but to get them back to work at higher productivity.
Senator Sarbanes. We want to do both of those things. But if you are tell-
ing me that you wanted money grovith to slow, you said inflation was going to
rise. Fortunately, money growth did not slow. In fact, some of us think it
should have increased even more. We don't think there is a pressing inflation
problem now on the horizon, and we end up with these limited or restriction-
ary policies, which I think are in part responsible for this large gap between
job recovery in this cycle and what we experienced in previous cycles.
David?
Representative Obey. All I was going to say is that, granted, productivity
increases are good in the long run. But as Dr. Solow pointed out in his state-
ment, if, in the short run, productivity increases reflect, at least, in part, the
fact that companies have been trying to do more with less, then in terms of
our ability to deal with the job lag as we come out of this recession, our prob-
lem is complicated by that productivity increase and, it would seem to me,
would require even more attention to the need, in the short run, to try and
make up for the downside of that productivity gain.
Senator Sarbanes. Professor Tobin, suppose we had followed this advice
and slowed money growth in 1992, and everything that that would imply,
93
which I assume would be a more restrictive or contractionary monetary policy,
what would happen to the economy?
Mr. Tobin. Well, I think we would have had very likely much slower pro-
gress on recovery than we did have in 1992.
Senator Sarbanes. We would have an even worse unemployment problem
on our hands?
Mr. Tobin. Yes, worse unemployment problem than we have now, al-
though I must say
Senator Sarbanes. And a bigger deficit probably, too. Wouldn't it be a big-
ger federal budget deficit problem as well?
Mr. Tobin. Sure. I must say that I think maybe monetary policy has not
been as potent in a positive direction as it was in previous business cycles. Al-
though tney haven't gotten interest rates as low as they should or could have,
they have gotten them pretty low. The banks' so-called credit crunch may
have attenuated the effectiveness of a given dosage of monetary policy, sug-
gested that perhaps they should have made the doses bigger in order to have
the same effect.
Senator Sarbanes. Mr. Solow, you want to add to that?
Mr. Solow. No, I don't have anything to add to that.
Senator Sarbanes. Let me ask you, do you see any valid basis now existing
in our economic circumstances that would warrant the Federal Reserve tight-
ening monetary policy?
Mr. Solow. If you are asking me, the answer is no.
Senator Sarbanes. Let's assume, as I put that question, that there is a mod-
est fiscal stimulus package that the President makes an initiative. They have
been talking in the range of $25 billion to $30 billion. Factor that in as part of
your thinking as you look at the economic landscape. Professor Tobin. I know
you feel that the fiscal stimulus should be larger than that in order to get the
economy back up toward its existing potential, let alone the problem or trying
to raise the potential. But do you see any factors that should lead them to
contract monetary policy in the face of sucn a fiscal policy?
Mr. Tobin. In my opinion, the Federal Reserve should certainly not do
that. They should let the fiscal stimulus have its chance without tightening
monetary policy.
Indeed, I would still favor some easing of monetary policy. If it were true
that the Federal Government were about to embark on a $120 billion per year
deficit-increasing package, then I could imagine the Federal Reserve having
concerns that logically lead them to tighten. But nothing like that is in pros-
pect. Even a stimulus as large as the one that I was proposing in Litde Rock
would be only 1 percent of GDP. That compares with a 4 percent gap on a
conservative Solow side of estimate of potential, or my 5 percent gap. It is a
long way from where we are, to where we need to be to get unemployment
back down and create the promised number of jobs in the coming four years.
I cannot see a threat of inflation, or overheating in the coming year or two,
that should lead the Federal Reserve to do anything to tighten policy.
Mr. Solow. I would just like to add, Senator, in response to the moderate
fiscal stimulus that we have been talking about here and that you just men-
tioned, if the response to that on the part of the Federal Reserve is to tighten
monetary policy, then it is, in effect, working at cross-purposes.
94
Senator Sarbanes. Sure. Cut the recovery off at its knees, put the recovery
off.
Mr. Meltzer. May I make a short comment on that, Senator?
Senator Sarbanes. I take it you think monetary policy should be tightened;
is that correct?
Mr. Meltzer. That is correct, but I believe
Senator Sarbanes. Because you fear inflation.
Mr. Meltzer. Not because I fear inflation but because there is a wide gap
between short- and long-term rates, which is now closing by having long-term
rates go down.
And that seems to me to be good news for the long-term growth of the
economy, to have long-term rates go down during a period of expanding out-
put. If long-term rates were going down because output was contracting, that
would not be good news, but going down during a period of expanding out-
put is a sign that people are beginning gradually to become convinced that the
present low rate of inflation may be maintained. It is important to get those
long-term rates down while the economy continues to recover.
The difference between short and long-term rates is an imperfect measure,
but nevertheless a measure of what people think inflation is going to do, not
tomorrow, but at some time in the near-term future. It is important to close
that gap not by having short-term rates rise but by having long-term rates
come down.
That gap has been the widest that we have had. That wide gap is a measure
of the lack of credibility that people have about the long-term outlook for in-
flation. We need to solve that problem, to bring it down if we are going to cre-
ate meaningful jobs, high productivity growth, do all the things that you want
to do. So I don't disagree with you about the goals. We disagree with the
method by which we are going to reach them.
Mr. Solow. Perhaps, Allan recognizes that another reason for long-term
rates to stay high is the belief on the part of the market that the Fed is about
to tighten credit.
Senator Sarbanes. Let me just read you this on that very point. This is an
exchange with Professor Samuelson. I want to get the comments from each of
you on it.
When he appeared before this Committee back on December 30, 1 put this
question to hirn:
I want to be clear on one point with respect to this steep yield curve. As
I understood your testimony earlier, making reference to the money
traders with whom you have been in contact, the high rates on long-term
securities, as you understand it from them, is attributable, at least in
part, to their expectation that the Fed will tighten monetary policy in
order to combat some inflation that they might see coming, or conjure
up as coming, as you begin to get a recovery. And, therefore, given that
position of me Fed, the longer-term securities are staying at a higher
rate; is that correct?
Professor Samuelson said:
Yes, and it is incorrect in my experience that these smart people in the
money market see bottlenecKS in the production process, which is going
to raise prices as soon as output rises, and see a resurgence of militant
union wage activity.
95
That is the explanation usually given. Mr. Hoskins, former head of the
Cleveland Reserve Bank, got into this debate at that time and I said to him:
How do you sc^uare the fact that, by any rational judgment, the appre-
hension about inflation should be less now than at other times in our
history, and yet the yield curve, according to your statement, is the
steepest it has ever been? That would only square if one could rationally
argue that the apprehension of inflation now is the worse it has ever
been. That is clearly not the case going back through the postwar period.
So we have had other periods of time when the apprehension of inflation
was reasonably much greater than it is now and the yield curve was not as
steep. Doesn't that lend credence to the point that is being made, that maybe
a contributing factor to the steepness of the yield curve is a perception that
the Fed is going to embark on this pohcy and that the interest rates are going
to go back up again? And I take it that that is the point you were trying to
make.
Mr. Solow. Yes. Yes.
Senator Sarbanes. "What is your view of that point, Professor Tobin?
Mr. Tobin. Senator, I think that these expectations about short rates are a
major factor in the formation of long rates, no question about it. And since
the Federal Reserve has the control of the shortest rates, then those are neces-
sarily expectations about Federal Reserve policy. Of course, they may arise
from expectations of events in the economy that would cause the Federal Re-
serve to raise short-term rates in the future.
Inflation might be one such reason, and another might be just general con-
gestion in the capital markets because of restoration of full emplojTnent and
heavy demands for investment. But neither of those things is imminent. They
are both a long way off. There is no particular reason to expect the Federal
Reserve, on a rational consideration or the economy, to raise short-term rates
no matter whether there is a fiscal expansion going on this year or not.
Senator Sarbanes. Or an economic recovery.
Mr. Tobin. Or an economic recovery.
Senator Sarbanes. "What is happening is, if you start to get an economic
recovery and you start to come up and get your head out of the water, then, if
they react to it very early on, they push you right back down again.
Mr. Tobin. I think it is very important for Congress and for the President,
whatever the economic climate, to have the Fed on his side. Indeed, publicly
on his side, so that the rational expectations about what will happen to infla-
tion and capital markets during the next several years will prevail over these
fears and nightmares. The markets need to be assured by the Federal Reserve
itself that it is not intending to take such action.
Senator Sarbanes. Thank you very much, Mr. Chairman.
Representative Obey. Thank you. Let me ask a few more questions before
we get you out of here. This has nothing whatsoever to do with what Presi-
dent Clinton is considering, but it is a question I have had in my mind for a
long time.
My predecessor in the Congress was Mel Laird, and while he was in Con-
gress he once proposed a piece of legislation which would have given the
President authority to raise or lower tax rates across the board by a given per-
centage in the interest of being able to manage the economy to a small degree,
to weigh against the wind in a countercycHcal manner.
96
Forgetting for a moment the jurisdictional desires of the Congress to pre-
serve its, quote, prerogatives, what would be wrong with giving the President
that kind of economic management tool so long as it were limited in scope
and so long as he could apply it only uniformly so that he would not be mak-
ing policy changes, but just trying to adjust in minor periods of economic tur-
bulence?
Mr. Tobin. You are asking two people here who are veterans of an effort by
the Kermedy Administration to get precisely that legislation through the Con-
gress. It was actually recommended by President Kennedy on the initiative of
his Council of Economic Advisers.
The idea was to agree in advance on a distributionally neutral kind of tax
change so that any kind of countercyclical use of taxation would not get
bogged down by debate about who was going to benefit, or who was going to
pay. I think it was a good proposal then. I think it is a good proposal now.
Representative Obey. I am not suggesting that that alone would suffice
now because, obviously, you had a very specific set of winners in the 1980s, in
terms of who cleaned up under the way the economy has performed and who
has cleaned up under the Tax Code, but if were you to get that base rate, I
don't see the harm.
Mr. Solow. The proposal was never that the Congress should not, when-
ever it wished, make structural changes to the tax laws. This is like old Yale
alumni thinking about the Harvard game of 1942, or something. We also had
included in the proposed legislation the provision that the Congress could
veto the President's action within 30 days or something like that, but the
President could act quickly so as to do this thing. And it still strikes me as en-
tirely sensible, apart from the jurisdictional problems.
Mr. Tobin. The proposal included an unemployment "trigger," also used for
extension of unemployment insurance.
In the present circumstances, given the priority for an investment-driven
fiscal policy for recovery, we might not want a consumption-oriented tax
change. Better we should concentrate on the investment tax credit and on
public investment.
Representative Obey. But do you think it would still be good after that, or
even coincidentally with doing that to put it on the books for long-term usage
in the future?
Mr. Tobin. Yes.
Representative Obey. Let me ask, what is the cost to the country and what
is the cost to average working people in this country of following Mr. Meltzer's
advice to simply accept the fact that the economy is now growing slowly?
Live with that? Don't try to rush it? Let it happen, quote, naturally? Para-
phrasing what I think your position is, Mr. Solow, what do you see as the eco-
nomic and social costs of that policy?
Mr. Solow. Well, the economic and social costs are primarily more pro-
longed unemployment than would otherwise be necessary with whatever that
means in terms of added stress on families, reduced willingness of individual
workers to take risks, greater burdens on children, and so on.
I also think that the costs would be measured in another way. I cannot be-
lieve that it is good for the long-term investment plans of business to be told
in no uncertain terms that when there is a recession their government pro-
poses to let the recession work itself out however long that takes. I can't think
97
that that would help the long-term investment plans of business, whose main
risk often is the cyclical risk of having long periods of bad times.
Mr. Tobin. I think there is some cost in prolonged cyclical lapses from high
employment, some cost in lost investment that is not necessarily ever made
up. Saving is lost, wasted in unemployment, instead of being used for invest-
ment for the future.
But I particularly wanted to add to what Mr. Solow said about the plights
of state and local governments, which are fiscal disasters right now. They are
short of funds for all kinds of good purposes. They are the vehicles for public
investment in infrastructure and education. And prolonging the recession, or
risking a triple dip or another in lapse in this recovery would make their situa-
tions much worse.
Mr. Meltzer. May I comment on that, Congressman?
Representative Obey. Okay.
Mr. Meltzer. First, I object to your characterization. The economy is not
growing slowly. In the last six months, it has grown at 3.75 percent. That is
about 1 percent above its average growth rate.
It is important also to note that no one predicted that very accurately. Most
people, as late as November, were revising their forecasts downward. So we
should have a bit of humility as we look ahead to the forecasts about what is
going to happen in 1993. Those were forecasts. The error around those aver-
age forecasts is about 60 percent of the average rate of growth of the econ-
omy. That is where it has been historically, so we could have a lot of different
scenarios in 1993, some better than the forecasts, some worse than the fore-
casts.
But we really don't know that. What we do know is that we have some
ways of getting sustained, durable, high productivity growth in the economy if
we don't repeat the mistakes that we made in the 1970s. It took us more than
ten years to unwind the policy mistakes of the 1970s. We ought to be cautious
before we start to repeat them.
Se.nator Sarbanes. Mr. Chairman, could I interject right there, because I
think it is very important to keep to keep us in a contemporary factual situa-
tion.
Professor Meltzer, I must say to you I don't think it contributes to under-
standing the problem, to take a 3. 8 percent fourth-quarter growth rate and
then say to us, if you look at the growth rates over a long time, this is a pretty
good growth rate. I mean, what we want to look at are the growth rates com-
ing out of a recession, which I think is more comparable since the growth rates
coming out of a recession are always at a higher rate.
Now, what this chart shows is the average of growth coming out of the four
prior recession recovery cycles was 8. 4 percent. Coming out of this one it was
2. 9. Now, this doesn't include the fourth quarter. That would move up at
about 3. 8 percent, but this one moved at about 4 percent. So the gap, in fact,
would actually increase a little bit from the gap that I am showing you here.
Mr. Meltzer. Yes.
Senator Sarbanes. Now, to come along and give me a growth figure taken
over a long stretch of time, instead of a growth figure that is related to the re-
cession recovery cycle, it doesn't seem to me to help us much in trying to ana-
lyze where we are. In fact, we have this very large gap in this recession
98
recovery cycle in terms of growth in GNP, compared with previous recession
recovery cycles. And, of course, the flip side of this gap in growth is the chart
that I showed earlier which shows that we are not recovering jobs. As a conse-
quence, we have all these unemployed people, and we are losing national out-
put which we otherwise could have available to us.
You made short shrift of that in your statement. I thought you dispatched it
away rather glibly in terms of the lost output. You referenced it, but you dis-
missed it. I think that is important. That is output that we now could be
achieving, and we could be addressing the unemployment problem.
Thank you, Mr. Chairman.
Representative Obey. Okay.
Mr. Meltzer. May I respond to that, please?
Representative Obey. Okay.
Mr. Meltzer. If your point is that the economy is growing at a slower rate
than the average recovery from recessions, and I would assume that is part of
your point, then I acknowledge that in my statement.
Senator Sarbanes. Significantly slower.
Mr. Meltzer. Significandy slower. I then gave four reasons why. Let me
repeat two of them very briefly.
Many of those recessions which were faster spilled over into inflation.
Those were not durable expansions.
As one very bad example, let's take the 1980 recovery, which spilled over
into inflation quickly ancf was aborted as quickly. Not all of them have that
record, but many of them have that record. I would like to avoid that because
I am interested in seeing productivity growth, good jobs being created, the
growth rate of the economy picked up in a durable, sustainable way.
Second, many of those recoveries did not have cutbacks in defense spend-
ing. When we have had cutbacks in defense spending, we know that it has
taken bits of time, a year to two, to absorb those people into new jobs. I think
that we will have the same problem in this defense cutback. And there are
some other reasons, but let me not go into them.
Representative Obey. Let me respond by making a couple observations.
First of all, I know of no significant testimony before this Committee which
would indicate that there is that kind of inflationary threat on the horizon.
Even Dr. Greenspan, whose responsibility it is more direcdy than any other
government official to oversee that, testified just about ten days ago that he
did not see that on the horizon. Second, I think you have to recognize that
while you raise skeptical concerns about any projections that anybody makes,
we recognize that most of those projections already include the assumption
that there will be some kind of moderate stimulus package. They build that
into their assumptions on economic growth for the future. And, third, it would
seem to me that because we do have a downsizing of the defense budget, that
is all the more reason to try to be adjusting on the other side.
I would point out that it is my observation that when we went through a
similar, and in many ways larger, problem at the end of World War II, I would
submit that Harry Truman did not just stand there and watch the military
budget become downsized and watch people come home without opportuni-
ties for jobs. He created two programs that provided some bridges.
99
For instance, the GI Bill. It may have been intentioned to help people get
an education, but it also was a convenient way to park an awful lot of people
in a productive enterprise; that is, enhancing their education and skill levels
by going into school for a number of years so that they could be phased into a
job market that wasn't ready to provide job opportunities for tnem immedi-
ately. And, second, it seems to me that the housing programs recognized that
in addition to meeting the social good, which the FPiA and VA housing pro-
grams met in those years and beyond, that it also provided a way to occupy a
lot of people in productive economic activity while the economy was being
shifted from a very heavily worked on footing to a more civilian-oriented
situation.
So, to say that our response to the defense downsizing should be to think
of doing less to counteract, that seems to me to be strange.
Mr. Meltzer. I suggest that there are a number of things you might do.
They just didn't happen to include short-term stimulus, but there are a lot of
long-term stimulus measures in my proposals, which I
Mr. Solow. I would like to add, sir, that the downsizing of the defense
budget, in real terms, began about five years ago, and we are long past the
time when we are capable of acting surprised and saying, oh, this is happening
to us.
Senator Sarbanes. Mr. Chairman, let me just close by underscoring the
point I was trying to make for the sake of analysis. In his statement. Professor
Meltzer describes the discovery as anemic. I happen to agree with that.
He then goes on to say:
I would not use that term to describe recent performance. Preliminary
data for the second half of last year showed a growth rate of 3 and 3/4
percent, well above average growth for the U. S. economy. I mean, aver-
age growth for the U. b. economy for 1992 as a whole, growth was
sUghtly above the historical average of 2.8 percent with only one quarter
below the average rate.
We are trying to analyze where we are in terms of addressing this recession.
In fact, Professor Meltzer gives himself a backstop on that because he then
goes on and says — and I think this is where the framework of analysis should
nave been: "Or course, the economy must grow at an above average rate dur-
ing recoveries to compensate for falling out during recessions. So we should
not be complacent about the recent record."
Well, I think that is the nub of the problem. And the fact of it is, we have
had this enormous gap between the growth out of this recession compared
with previous recessions. Obviously, it has to grow above average rates, and it
is not doing that. It is doing well below in comparison with these previous re-
cessions. And that is our problem in terms of recovering the jobs. And that is
what gives such an urgency, I think, to the President's concern about having a
package that is going to give us job restoration. The President understands we
have to get jobs back. We have got to get people working and producing.
Representative Obey. I would agree with that.
Let me thank you gendemen for coming and observing, as this discussion
has made quite clear this morning, that we do have a short-term problem
which most of us view as being a weak recovery in comparative terms, with
the resulting impact on human beings that it has in terms of lost income and
wages, and with the resulting impact on the deficit.
100
I would point out one of the quickest ways that we could reduce the size of
the deficit would be to reduce the unemplo>Tnent level by a percent and a
half. You woiild have a substantial reduction in the deficit, far larger probably
than any one specific change which the President uill recommend.
And it also seems to me that we in fact have three deficits — the budget
deficit, the investment deficit and the growth deficit — which we have to
tackle simultaneously. Unless we attack all three, we are simply not going to
overcome the deficit in family income which, after all, was supposed to be the
goal of economic policy. I believe, based on what the President has said so far
and certainly what he said last night, he understands that.
Now, we have heard some macroeconomic advice this morning, largely on
how we ought to deal with that problem. This afternoon, beginning at 1:00
p.m., we will hear a panel which will be describing what they feel we ought to
do to deal with the investment deficit on the human side of the ledger, which
we talked about this morning. And tomorrow we will have another panel
which talks about what we ought to be doing about the other pieces of that
investment deficit.
If I could just go back to the investment deficit chart before we quit, I
think it is, again, important to emphasize that while we deal with that federal
deficit, this is a terribly important part of the equation. Any time the govern-
ment itself — its own budget — has reduced the share of our federal budget,
which we devote to long-term investments, by more than 40 percent, it indi-
cates that we have been going in the wrong direction in terms of policies
needed to strengthen the economy long term. This is the question to which we
will turn to in this afternoon's hearing.
Senator Sarbanes. Mr. Chairman, could I put one final question to Mr.
Tobin?
Representative Obey. Okay.
Senator Sarbanes. I am increasingly concerned that the use of these mone-
tary aggregates, as some kind of measure of policy, really don't get at what we
need to know, and I am curious as to whether we should be thinking of devel-
oping some way in which the Federal Reserve will present its goals in terms of
key aspects of the economy. In other words, they are trying to set a monetary
policy to accommodate this kind of grouth, this kind of employment, this
kind of price level, and so forth, so you are actually getting at the real vari-
ables that impact on people's lives. Do you see any profit in trying to explore
that path?
Mr. Tobin. I do indeed. I can imagine that we could sit here all afternoon
with Professor Meltzer and myself, and Bob and you, and not coming to
agreement on that. But I do think that it is more important to have the Fed-
eral Reserve come to the Congress and express its goals for macroeconomic
performance in terms of things that really matter — growth of GNP, what hap-
pens to employment and unemployment, investment and foreign balance, and
inflation. They should talk with you about their appreciation or the macroeco-
nomics circumstances in which they are making policy, and the general direc-
tions in which they hope to move the economy in the coming six months, or in
the coming year. The intermediate and operating instruments that they use
should be derived from those goals.
Those goals could be discussed by the Congress, the Administration and
the Federal Reserve so that there is a coherent macroeconomic plan of fiscal
101
and monetan' policy. There could then be a common strategy. The parties
would not be working at odds against each other. Then I would leave it to the
Federal Reserve to decide by what instruments — interest rates, reserve targets
and so on — they would carry out their part in this macroeconomic strategy.
Senator Sarbanes. Thank you very much.
Represe.\tati\t Obey. Thank you, gendemen. I appreciate it. We will re-
sume at 1 :00 o'clock.
[Whereupon, at 12:40 p.m., the Committee recessed, to reconvene at 1:00
p.m., the same day.]
O
102
SUBMISSIONS FOR THE RECORD
PREPARED STATEMENT OF JAMES TOBIN
(Presentation at President-elect Clinton's Economic Conference,
Little Rock, December 5, 1992)
The United States suffers simultaneously from two macro-economic maladies.
One is short-run and cyclical; the other is long-run and secular. The first is demand-
side; the second is supply-side. The first is that spending on goods and services cur-
rently falls well short of the economy's capacity to produce them. The second is that
productive capacity itself had been falling behind the needs and aspirations of the na-
tion. The first has resulted in a shortage of jobs. The second is eroding the quality and
real wages of jobs.
The great challenge of the Clinton Administration will be to provide remedies for
both maladies. It won't be easy. The key to job creation in 1993 and 1994 is more
spending, private or public, domestic or foreign, consumption or investment. The key
to better real wages over the next two decades is faster growth of productivity, requir-
ing greater national saving and investment.
Growth of the capacity of the economy determines the trend of real Gross Do-
mestic Product (GDP) over the decades, across business cycles. Potential GDP at full
employment — now about 5 1/2 percent unemployment — grows nowadays at about 2
1/2 percent per year. Half of that is due to the normal increase of the labor force, the
other half to productivity. Productivity is growing much more slowly than before 1973,
and more slowly than in other economies today. This is the long-run, supply-side mal-
ady. We need to raise productivity and the speed of its growth for the benefit of future
Americans.
The short-run demand-side problem is that we haven't even kept up with the
growth of capacity. 2 1/2 percent is the sustainable growth rate. If (GDP rises at that
pace, it will just absorb the influx of new workers and the unemployment rate will re-
main constant. If GDP grows more slowly or actually declines, the unemployment rate
will increase. The 2 1/2 percent sustainable rate, not zero, is par for the U.S. economy.
Relative to that par, we've been in recession — call it "growth recession" — for nearly
four years; although GDP change was positive in most quarters, growth was usually
slower than 2 percent annual rate. That is why unemployment increased by two per-
centage points, about 2 1/2 million workers. As a result, GDP has by now fallen 5 or 6
percent below capacity.
To catch up in four years, we have to grow faster than the sustainable rate, indeed
on average 1 1/2 percentage points faster. GDP growth averaging 4 percent will be
needed to bring the unemployment rate back down to 5 1/2 percent in 1996, by creat-
ing 8 1/2 or 9 million jobs — for roughly 5 or 5 1/2 million new workers, 1 million per-
sons re-entering the labor force, and the 2 1/2 million now unemployed.
Will this catch-up recovery occur on its own? Or do we need fiscal stimulus to pep
up demand for goods and services and for labor? There is, I believe, a strong case for
stimulus. The labor market is weaker than the unemployment rate suggests. The num-
ber of employed workers involuntarily confined to part-time jobs is abnormally large.
Job vacancies, as indicated by the Help-Wanted Index, are extraordinarily scarce. De-
fense cutbacks and corporate downsizings are destroying jobs irreversibly; to an un-
usual extent hirings in this recovery will have to be truly new jobs. Although some
recent macroeconomic numbers — notably, third quarter GDP — are encouraging, re-
covery is by no means in the bag. Typically growth spurts in the first year and then
tapers off; no such spurt is now evident or forecast. Among other unpromising de-
mand prospects are the slumps in Europe, Japan, and throughout the world, which
103
together with the appreciation of the dollar curtail U.S. exports, the forced beh-
tightening of state and local governments, and the sluggishness of business and house-
hold investments.
Improved productivity growth recently reported, if not transitory, means that po-
tential GDP is higher and growing faster than estimated above. That would be good
news for the long run. But its flip side would be that extra demand expansion would
be required to achieve full recovery in four years.
Why can't the Federal Reserve do die job by itself, without fiscal help? One im-
pediment is the banks' "credit crunch." Short-term interest rates are already very low.
It may be that the Fed acted so litde and so late from 1989 on that, as in 1930-31,
they destroyed business and consumer expectations of recovery and let the economy
slip out of their grasp. And after all, in virtually every previous cyclical recovery since
World War 11, monetary policy has had active fiscal help.
Nevertheless, the Fed still has three hundred basis points between here and zero,
and they should lower rates further. The new President and Treasury Secretary will
want to do their best to induce the Fed to be accommodative and to help reassure the
bond markets. After all, no inflation cloud darkens the sky, and congestion of the
capital markets is at least as distant as fuU recovery. Also, we may hope that Secretary
Bentsen will not let his debt managers supply the markets with any more long-term
high-interest bonds.
Fiscal policy for recovery is bound to raise the budget deficit temporarily. (Among
the virtues of an Investment Tax Credit is that it delivers a big bang of demand stimu-
lus per dollar of lost tax revenue.) I recommend stimulus of $60 billion a year for the
two years 1993 and 1991, about 1 percent of GDP, capable thanks to secondary "mul-
tiplier" effects of adding 1.5 percent to GDP demand, a modest count relative to the
6% shortfall of GDP from its potential. The ratio of federal debt to GDP, which rose
from 25 percent to 50 percent over the past twelve years, would be about one percent-
age point higher than otherwise. That price is worth paying for assuring a vigorous
recovery.
Fiscal stimulus for recovery should be combined with credible deficit-reduction
policies to be phased in later, so far as possible enacted in 1993. For deficit control as
well as for its own sake, nothing is as important as health care reform. Otherwise fed-
eral outlays for Medicare and Medicaid will bust the budget throughout this decade,
in particular rising by nearly 2 percent of GDP from 1996 to 2002.
In today's weak economy, immediate fiscal austerity could be counterproductive.
It would raise unemployment. It would actually reduce investment for the future, thus
doing harm rather than good to coming generations. The story will be different in ro-
bust prosperity three or four years from now. Once the economy is again producing at
capacity, there will be no room for additional productive investment unless other de-
mands on GDP are reduced — that is, unless the country caves more. Federal deficit
reductions are the prime way to raise national saving — provided they occur at the ex-
pense of private and public consumption, and provided that the Fed lowers interest
rates enough to channel saving into investment rather than going to waste in unem-
ployment.
In the meantime the Clinton administration has the opportunity to provide in con-
structive ways the fiscal stimulus needed for recovery. The much-touted 1980s recov-
ery, fueled by the most massive deficits in peacetime history, were incurred for
defense buildup and for tax cuts for affluent consumers. Those deficits had no lasting
payoffs in productivity and growth. In admirable contrast, Clinton programs of private
investment incentives and public investments in infrastructure and human capital
would leave behind them important permanent gains.
104
Figure 1
RECOVERY 91:1- V. AVERAGE RECOVERIES
3
O
a
c
o
12 quorters from trough=100
3 5 7 9
quarters since trough
O Actuol 91:1-92:4-
assumed 3.2% 93-94 o ovg, 7 recoveries
The 7 recoveries averaged in the higher path are those starting from NBER reces-
sion trough quarters 1954.2, 1958.1, 1960.4, 1970.4, 1975.1, 1980.3, and 1982.4. For
each recovery GDP in 1987 dollars is converted to an index with the trough quarter
observation equal to 100. Twelve quarters of recovery are counted, even if a new re-
cession began during that span. The average is compared with the recovery from the
1991.1 trough. Since observations of the current recovery are not available after
1992.4, the five subsequent quarters plotted assume 3.2% per year growth. This is an
optimistic assumption, but still leaves the path of the current recovery far below that
of the average.
105
(0
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0
c:
s
o
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106
Figure 2
REAL GNP, ACTUAL Sc POTENTIAL 1950-1992
a
In notural logs, ouarterly, '87 $'s
50.1 I 54.1 I 58.1 I 62.1 i 66.1 I 70.1 I 74.1 i 78.1 I 82.1 I 86.1 I 90.1
52.1 56.1 50.1 54.1 58.1 72.1 76.1 80.1 84.1 68.1 92.1
year: quarter
In gnp87
In potential gnp87
Here the smooth path is that of Potential GNP in 198 7 dollars (PGNP), and the
wavy path is that of actual real GNP. PGNP is a hypothetical number, conceptuaUy
intended to represent the full employment capacity of the economy as a whole in nor-
mal peacetime circumstances, In this framework, business cycles are fluctuations of
actual GNP around its smooth longer-term trend as shown by PGNP. "Full employ-
ment" can be thought of as corresponding roughly to the lowest rates of unemploy-
ment and excess industrial capacity- consistent with avoiding sustained increases in
rates of general inflation. Along a PGNP path, or any path parallel to it, rate of unem-
ployment and capacity utilization are constant. The growth rate along such a path is
the economy's sustainable rate, the sum of the rates of increase in the labor force and
in productivity' per worker, without changes in unemployment rates. In the Figure, the
sustainable PGNP growth rate is taken to be 3.5% per year until 1973:4 and 2.5%
thereafter. Likewise, the unemployment rate along the PGNP path rises from about
4% in the pre- 1974 period to roughly 5 1/4 percent in the second period.
107
Figure 3
GNP GAP &c UNEMPLOYMENT RATE
c
£
o
a
5
»
c
O
Quarterly 1950-1992
.1 I 54.1 I 58.1 I 62.1 I 66.1 I 70.1 I 74.1 I 78.1 I 82.1 I 86.1 I 90.1
52.1 55.1 60.1 54.1 53.1 72.1 75.1 80.1 84.1 88.1 92.1
year & quarter
% gnp gop (lower)
unemp rate (higher)
The upper path is that of the civilian UNEMPLOYMENT RATE. The lower path
is the track of the GNP GAP, the percentage difference between actual GNP and
potential GNP (PGNP), exactly as graphed in Figure 2. The GAP is negative when
GNP exceeds its Potential, of which a major symptom is an unsustainably low unem-
ployment rate, as in the periods of war in Korea and Vietnam. As this figure shows,
the ups and downs of the two quarterly series are strikingly similar. However, the am-
plitude of the GAP is two or three times greater than that of the UNEMPLOYMENT
RATE. This figure illustrates "Okun's Law," perhaps the most reliable and important
regularity of macroeconomics. It explains why it takes a 2 1/2 percent increase in
GNP relative to PGNP, plus or minus, to lower unemployment by one percentage
point.
108
Figure 4
o
X)
o
o
Layoff and Total Unemployment Rates
Nov. 1992 compared to 5 Cycle Troughs
Nov. 1970
Mar.1975
Nov.1982
layoff unempl rate
Nov.92
s>SS^ totol unempl rote
The "total" unemployment rate is the conventional civilian unemployment rate, i.e.
the count of unemployed workers relative to the labor force. The "layoff rate is the
count of unemployed workers who say that they have permanently lost their jobs, rela-
tive to the same labor force. Both are shown for five cyclical trough months, and fi-
nally for November 1992, a recovery month 20 months after the last trough. The
point is that layoff unemployment currently is at rates usually associated with cyclical
troughs and with higher rates of general unemployment.
tion.
I am indebted to Professor James Medoff, Harvard University, for this informa-
109
9
c
o
o
o
Figure 5
Layoff&Totol Unenipl Rates<&:Vacancy Index
Nov. 1992 compored to 5 Cycle Troughs
Nov. 1970
Mar. 1975
Nov. 1982
Nov. 9:
n layoff unempi rote
+ total unempi rote o vacancy index 67=10
The two unemployment rates of Figure 4 are plotted here, for the same six
months as in Figure 4. The additional information is a Vacancies Index, intended to
be dimensionally comparable to unemployment rates. It is computed as the ratio of
the Conference Board Help Wanted Index to an Index of NonFarm Employment,
both with the 1967 average equal to 100. The ratio itself is normalized to make its
1967 value 10, in order to facilitate graphical comparison to the unemployment rates.
The point is that recently vacancies have been surprisingly scarce considering the com-
paratively low unemployment observations in 1991 and 1992.
tion.
I am indebted to Professor James Medoff, Harvard University, for this informa-
no
PREPARED STATEMENT OF ROBERT SOLOW
It is a real pleasure to help start off this year's series of Joint Economic Committee
hearings, and I thank the Committee for the opportunity. I am not just being polite
when I say so, Many people, not just a few economists, hope that the way is now open
to thoughtful and cautious activism on economic policy. It is a privilege to be asked to
make a contribution to this process
We live in the short run, and I am sure that most of your discussions in these
hearings will be about the immediate prospects for our economy, the size and shape of
the appropriate fiscal stimulus, if any, and the deficit that came to dinner. We can get
to those questions in due course, but I would like to begin by talking a slightly longer-
run point of view, focusing on the linked issues of jobs and Productivity. I hope in this
way to avoid the danger that is always present in discussions of any kind of policy, that
we redouble our efforts as we lose sight of the goal.
You will remember that during the 1980s, at least after the deep recession of
1981-82, the U.S. economy was in one important respect the envy of Europe and
much of the world. Between 1982 and 1990 we generated 20 million payroll jobs. We
had the luxury of worrying that about 19 million or them were in Service-producing
industries. During that same period the advanced industrial economies of Europe ex-
perienced only trivial increases in employment. One's euphoria about this contrast gas
tempered by the observation that U.S. productivity — output per hour worked in non-
farm business — rose by only eight percent during the same long upswing These two
facts are connected by a piece of arithmetic: the rate of growth of employment and
the rate of growth of productivity add up to the rate of growth of output. Given the
path of productivity, we could have had faster or slower growth of employment if we
had managed faster or slower growth of output. (It is natural to take the growth of
productivity as the "given" in the short run, although that is not quite true.)
We may be seeing the dark side of that success now. Everyone is painfully aware
that payroll employment today is still lower than it was in 1990. Despite all the favor-
able straws in the wind in' recent months, the country has not yet managed a monthly
increase in employment large enough to cut into open and hidden unemployment.
Even more ominous is the drumbeat of announcements of major layoffs at flagship
corporations: IBM, General Motors, United Technologies Sears, and others. In this
context, it does not sound like good news that non-farm business Productivity is up
four percent in the past two years. Given that pace of productivity growth it would
take a considerably faster increase in output to generate a decent number of jobs. It
looks as if all that job growth in the 1980s may have been too cushy to last. Busi-
nesses, including those large ones, may have added workers that they did not really
need. The competitive pressure to cut costs and eliminate uneconomic capacity is now
working in the opposite direction.
Any increase in productivity is a good thing when looked at from the cost side.
The sort of labor-shedding we are seeing now, the squeezing-out of workers who are
associated with capacity that can not earn its way or are not really needed for the effi-
cient operation of viable capacity, is necessary and, in its way, useful. At least it tells us
that we have labor resources to use elsewhere in the economy if we can generate the
demand for the goods and services they might produce. But labor- shedding is a lot
less promising than the productivity gains that come from the appearance of new capi-
tal and new technology and that themselves represent additions to state-of-the-art ca-
pacity. We would be better off in every run if we were experiencing bore more of that
kind of productivity gain.
These questions are central to an evaluation of the current state of our economy
and the room it offers for expansionary fiscal and monetary policy. They are part of
the thought behind thoughtful activism. We know that our economy is not using all of
its capacity to produce and not employing enough of its available labor. The Federal
Reserve's Index of Capacity Utilization in Industry stands at about 79 percent,
Ill
whereas it was above 84 percent in the first half of 1989. To frame a policy we need a
notion of how much higher GDP could be this year and next without pushing up
against the barriers that could revive inflation.
Suppose we take 1988, when the civilian unemployment rate was 5'/: percent, as a
reasonable benchmark. How fast has potential GDP been growing in the last five
years? Experts differ: 2.0 percent a year is on the low side and 2.5 percent a year is on
the high side. Most of the model-builders would setde for something in betu'een. Pro-
ceeding that way suggests that the current gap is about four percent of GDP, meaning
that we are about $250 billion short of our potential production. The history that I
was sketching a minute ago suggests that there may be a little extra uncertainty in
these estimates, with the cushion being perhaps a trifle bigger than it looks
Now what about the immediate future: how fast will potential GDP rise in the
year ahead? A pessimist would stick with two percent, an optimist might be a tad be-
low 2V2 percent. I will opt far 2Va percent, recognizing that all this smacks of more
accuracy than one can hope for. If actual GDP grows by 2Va percent during the four
quarters of 1993, the gap between actual and potential will still be 4 percent early in
1994, and the unemployment rate will regain near 7.1 percent. It would take faster
growth of GDP to narrow the gap and reduce unemployment. Every increment of one
percent to the 1993 growth rate eats up One percentage point of the initial gap, and
reduces the Unemployment rate by four- or five-tenths of a point.
The beat mainstream forecasters now expect real GDP growth of 3.2-3.4 percent
in 1993. Most of them are busy shading those forecasts upward because recent bits of
news have been pretty good, though not overu'helming. It is important to reali2e that
these forecasts already presuppose a shall stimulus package early this year, generally in
the range of $15-20 billion.
If that story were to come true, you would be back here a year from now looking
at & GDP gap of almost 3 percent and an unemployment rate near 6.5 percent. I sup-
pose you could say that things were getting better, but I would award only a gentle-
man's "C" to that kind of performance. There is enough slack in the economy to
warrant a more aggressive approach. The payoff would be higher output, more jobs,
with little danger that inflationary pressure would return. It seems to me that 4 + per-
cent GDP growth in 1993 is a fairly conservative target for policy. That would require
a stimulus package near $3s biUion and accommodative monetary policy, A year from
now the gap between performance and potential would be cut nearly in half and the
unemployment rate would probably be nearer 6 percent than 6.5. I emphasize that
this is a reasonably cautious approach. It would leave some slack in the economy, and
something to think about for 1994. There would be room for the unemplojTnent rate
to come down sole more.
Now I will confess that I am an expansionist at heart. If the choice were really
mine, I would probably go for a bit more than I have recommended so far. Deep
down, I do not really believe that an economic expansion is like a popsicle in the sense
that the slower you lick it, the longer it lasts. I think there may be more slack than the
standard figures allow. But I am putting aside my natural aggressiveness and trying to
be mature.
If I can take a rmnute or two more, I would like to say something about the com-
position of a stimulus package. The general principle is that we would be trying to fa-
vor investment at every turn, at the expense of consumption. An investment tax
credit for equipment should definitely figure, and so should a permanent R&D tax
credit It would add effectiveness if the ITC were temporary, or at least had its rate
tapering from a higher temporary rate to a lower permanent rate, I would vote for
some productive infrastructure, but I would not go hog-wild on what is rapidly becom-
ing a buzzword. The goal should be to do those things that enhance the productivity
of private production. Most of those things will involve maintenance, repair, and the
proper pricing of congested facilities. Monuments are part of the problem, not part of
the solution. My hopes for faster growth of potential ride primarily on industrial
112
equipment, industrial R&D, and a higher-quality labor force. Expenditures on those
items are almost sure to do good.
Timing is everything. The most effective time for stimulus is soon. The sooner the
economy picks up momentum and gets closer to capacity the sooner it will be possible
to turn to reducing the deficit, and providing domestic saving for what we all hope will
be a permanendy higher rate of investment.
I want to make only two general points about the deficit-reduction phase of cur-
rent policy. The first is that the credibility of the program is far more important than
another $10 billion added to or subtracted from the target deficit 4 or 5 years down
the road. The deficit-reduction part of the program should be definite, detailed, con-
crete and specific about the taxes to be increased and the expenditures to be cut, and
when. It is hopeless if you are seen just to be saying "Yes, dear."
The second point foUows from the first. Once you and the Administration commit
yourselves to a path of deficit reduction, you will have surrendered your ability to re-
spond to macroeconomic surprises by making short-run adjustments to macro-
economic poHcy. You will have lashed yourselves to the mast, like Ulysses and the
Sirens, and for much the same reason. Macroeconomic stabilization will be in the
hands of the Federal Reserve. You should make damn sure that the Federal Reserve
understands and accepts its responsibilities for our economy. Treasury debt manage-
ment can help — as it can and should help right now by shortening the average matur-
ity of the debt — but the Fed will be the main player.
113
PREPARED STATEMENT OF ALLAN MELTZER
The economy continues to expand as we enter 1993. In contrast to the many
gloomy forecasts and interpretations of statistical data, that captured the headlines,
last year, this growth cannot be explained as mainly the result of special, non-
repeating factors. "Special factors" did not work one way; they include the cutback in
defense spending which has worked to slow the recovery.
Your letter describes the recovery as "anemic". I would not use that term to de-
scribe recent performance. Preliminary data for the second half of last year show a
growth rate of 3-3/4%, well above average growth for the U.S. economy. For 1992 as
a whole, growth was slightly above the historical average of 2.8% with only one quar-
ter below the average rate. This performance hardly justifies the mountains of paper
that have been used to describe the economy as stagnating or anemic or to forecast
second and third "dips" into recession that, we now know, did not occur.
Of course, the economy must grow at above average rates during recoveries to
compensate for falling output during recessions, so we should not be complacent
about the recent record. But we should also avoid additional short-term stimulus
based on faulty interpretations. Policy in 1993 should concentrate on encouraging sus-
tained growth and productivity to continue the very promising improvement in pro-
ductivity achieved during this recovery.
There are at least four reasons why the recovery has been slower than the postwar
average. First, many of the earlier, more rapid cyclical expansions laid the seeds of fu-
ture inflation followed by disinflation and recession. The main reason: excessive
money groAvth in the early quarters of recovery later spilled over into inflation. In the
1960s and 1970s, and again in 1985-86, excessive money growth encouraged rapid
spending growth, so that within a few years we had to choose between rising inflation
and either slow growth or another recession. Remember the Carter years? Second,
mild recessions are typically followed by slow recoveries. Despite many fanciful allu-
sions to the Great Depression, the 1991 recession was one of the postwar era's mild-
est. Hence the recovery should have been expected to be — and has been — mild.
Third, the recovery has labored against si2able defense cutbacks. It has not been pos-
sible to beat swords, tanks and airplanes into plowshares or machine tools without
making sparks. The worst performance in this recovery is concentrated in California
and the Northeast — where defense industries and electronics have reduced employ-
ment much faster than peacetime jobs have been created. The 1991-92 experience is
broadly similar to that of the Korean and Vietnam defense cutbacks. In those experi-
ences, it took at most 2 years to absorb most of the former defense workers. Fourth,
falling real estate prices have been a problem for banks from Vustralia and Japan to
Britain and the U.S. The Fed met this challenge with moderate monetary expansion
that lowered interest rates but did not reflate real-estate prices. Lower interest rates
improved banks' profitability (probably sparing us the cost of a bank bailout) and let
many property owners refinance with lower carrying costs. Avoiding reflation pre-
served the benefits of lower inflation and encouraged the cuts in long-term interest
rates that are essential to the transition to lower inflation. These reductions in long-
term rates have continued in 1993.
There are costs to a slow recovery but, so far, the costs have been small and there
are some offsetting benefits. The long-term benefit of a cutback in defense spending is
the resources released for private use. Until the recent slow recovery, many critics
wailed about our low saving rate. It is too soon to know whether slower growth of con-
sumer spending during this recovery indicates transition to a higher average saving
rate or is a temporary change.
Inflation has slowed. Slower inflation has many benefits. The rate of wage increase
is now aligned with productivity growth. Unit labor costs for U.S. industry have fallen
relative to foreign competition, so that exports have continued to grow despite reces-
sions in many overseas markets. Lower inflation reduces the tax on durable capital
.114
that results from the failure to index depreciation allowances. If low inflation is sus-
tained, it will be a lasting benefit for capital-intensive industries. It is beyond logic to
suggest that the government should offer firms an investment tax credit while raising
the hidden tax on capital by increasing future inflation.
The best available evidence suggests that long-term growth is not changed by the
slow pace of recovery. The difference between the recent 2-3/4% or 3-3/4% and a
more rapid 4% or 5% recovery will be made up in future years. A durable recovery and
prolonged expansion is important for making up the difference. Future income is not
equivalent to current income, of course, so there is a cost to slow recovery. But the
cost is only a small fraction of the difference between 2-3/4% and 4% growth for a
year or two. And if inflation continues to decline, the loss will be compensated in
whole or part by the benefits of lower inflation. And low inflation will extend the years
of expansion.
The Role of Monetary Policy
Some critics of the Fed, and some members of this committee, have been critical
of the slow growth of a particular broad measure of money known as M2. In the past,
M2 growth has been a reliable indicator of long-term growth of nominal GDP. Iliere
is no reason to believe this long-term relationship has changed.
However, the short-term relation between the growth of M2 and the growth of
nominal GDP has always been subject to relatively large departures from the long-
term relation. Forecasts of near-term spending based on M2 have often been subject
to relatively large errors. The same is true of the more complex interactions in large-
scale computer models containing hundreds of equations. Indeed, all short-term eco-
nomic relations are subject to large errors. Few forecasters predicted the jump in GDP
growth in the second half of last year. Until November, some were still revising down-
ward their forecasts and predicting a return to recession in the 4th quarter. It would
be a mistake to give credence to the cacophony from these croaking Cassandras. We
should choose policies that promote sustained growth with low inflation, not short-
term recovery.
There are other reasons for giving litde weight to the recent sluggish growth of
M2. 1 wiU mention two.
The first, repeats that the short-term relation between M2 growth and spending
has always been subject to large fluctuations. There is nothing particularly striking
about the size of the recent differences between growth of M2 and spending. So, it is
not prudent to put heavy weight on recent short-term growth of M2 in the absence of
other supporting evidence.
Second, other measures of money do not show the same pattern as M2. Money
issued by the Federal Reserve is called the monetary base. The base consists of the
reserves that banks hold and the currency that we all use. Every stimulative action to
increase money and credit increases the amount of monetary base outstanding. And,
when the Federal Reserve reduces the monetary base, measures of money and credit
fall.
The base and all measures of money include holdings of U.S. currency by foreign-
ers. Much of this currency is held outside the U.S. It is not used for domestic spend-
ing, so it does not affect U.S. GDP. Foreign holders of U.S. dollars include citizens of
Eastern Europe, the former Soviet Union, and Latin America who seek to avoid the
heavy cost of inflation in their own countries. Criminals, including drug dealers, use
currency extensively. Their transactions do not affect reported GDP.
For some time, economists have known that the dollars held abroad are a substan-
tial fraction of total currency circulation. Estimates based on shipments from the
United States or guesses based on observation of the volume of dollar transactions in
countries like Russia, Poland or Argentina suggested that perhaps 50% of U.S. cur-
rency was outside the country. A recent study raised the share of foreign holdings to
nearly 60%. Foreign holdings have been growing about 8 to 10% a year. Since these
115
holdings do not affect U.S. GDP, growth of domestic currency held abroad should be
removed from the monetary base.
The chart shows the relation between growth of spending (GDP) and growth of
the domestic monetary base — the monetary base net of estimated foreign holdings of
U.S. currency. The chart compares the growth of spending (at annual rates) in a given
quarter to the annual growth of the domestic base for the period ending six quarters
earlier. Like all such relations, this one is subject to change. If the relation holds,
growth of the domestic base predicts growth of spending in 1993. 1 read the chart as
saying that — contrary to the current critics — the Fed eased money throughout the cur-
rent recovery. There is now considerable monetary stimulus.
The message for the future is that continued growth of the domestic base at re-
cent rates will be adequate to sustain recovery and will raise inflation, perhaps by
1994. Now is the time to stabilize the economy and prevent that increase. Prudence
calls for about 2% less growth of the domestic monetary base than the average of the
last two years. This would lock in the gains against inflation brought about by the tight
monetary policy from 1989 to 1991 and contribute to a durable, expansion with low
inflation. It would avoid repeating the counterproductive policies of the 1 970s that
led us from boom to inflation to bust.
PRODUCTIVITY AND EMPLOYMENT
Productivity growth in 1992, 3% from 4th quarter 1991 to 4th quarter 1992, was
the largest increase in twenty years. In manufacturing, reported productivity growth
has shown improvement for almost a decade but service sector productivity has not.
Recent estimates suggest that, after falling through the 1 970s and 1 980s, service sec-
tor productivity has shown a sustained increase since early 1990. Service sector output
per private service job — a broad measure of service sector productivity — reached a
peak in 1976, declined until 1st quarter of 1990, and has now advanced 5-1/4% from
that base to recover in 2-3/4 years almost the entire decline of the previous 13 years.'
This recovery of service sector productivity growth is very welcome. Productivity
growth is the necessary condition for sustained growth of real incomes and living stan-
dards. During the postwar expansion, the service sector has been by far the largest
source of new jobs. This will continue to be true. Consider this: the Federal Reserve's
index of manufacturing production increased from 18 in 1946 to 110 in 1992, but the
number of production jobs in manufacturing are no different now than in 1946. Most
of the 67 million jobs created since 1946 are in the service sector.
Productivity growth not only raises standards of living, but the historical record
suggested to Simon Kuznets earlier, as it has to me recently, that over long periods
economic growth narrows the spread of the income distribution. Everyone gains from
growth but lower income-earners gain relatively more so that income differences nar-
row slowly but steadily. In the 1980s, this long-term relation between growth and in-
come distribution was disrupted, mainly by changes in returns to education that
worked to widen the income distribution. 1 believe the long-term relation will continue
to hold. To raise real incomes and spread the benefits widely, we should choose poli-
cies that have long-term benefits. 1 make some suggestions below.
The opposite side of increased productivity growth is the slower growth of employ-
ment during the recovery to date. When combined with the loss of jobs in the defense
and defense-related industries, we get below average growth in employment and the
highest unemployment rates concentrated in the states with larger defense related ac-
tivities. For 1992, the average unemployment rate in the ten states with heaviest con-
centration of defense spending was considerably higher than unemployment in the
other 40 states.
' Based on service sector output per private sector service job in 1987 dollars. Service sector out-
put is real consumption of services minus real net export of services. Data from H. Erich Heine-
mann, Ladenburg, Thalman, Co., NY.
116
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117
POLICIES FOR GROWTH AND PRICE STABILITY
Much current discussion suggests that the most urgent necessity is to reduce the
deficit while increasing spending to provide short-term stimulus. 1 do not share that
view. The recovery will continue without additional short-run stimulus. The reported
deficit is poorly measured and overstated. The budget deficit is not as much of a prob-
lem as is widely repeated.
More important, and deserving of more attention, is how money is spent, how re-
sources are used, and how the deficit is financed. If we as a nation, incurred the same
deficits, but used all of the borrowed money for productive investment in human and
physical capital, we would be much richer and would have higher living standards. The
economy would generate revenues sufficient to reduce debt in the future.
Public policy has discouraged investment in several ways. Depreciation is not in-
dexed, so inflation is a tax on invested capital, particularly long-lived capital. The 1986
tax act shifted taxes from consumers to owners of capital. Earned income — including
saving— is taxed and is almost certain to be taxed at higher rates beginning this year.
Taxing saving is not a way to encourage growth and raise living standards. Taxes
should be shifted from earned income to consumed income. This could be done, most
readily, by allowing taxpayers to subtract their annual saving from adjusted gross in-
come and levying the tax on the remainder — spending or consumed income. This
change would increase saving. Corporations should be allowed to write off all or most
of their purchases of machinery and equipment. This would increase productive in-
vestment and productivity.
Encourage general research and development and improvements in the quality of
education and training by promoting competition in schooling and by increasing in-
centives for learning. In many coimtries, school grades and performance are important
for getting a first job. This encourages effort and learning. This is not true in the
United States. In am told that one reason is that our laws would treat such informa-
tion as evidence of discrimination.
The choices you make will be important, but often your most important decisions
are what you reject. This is particularly true now.
Avoid the drift into protectionist policies and reverse the quotas and voluntary re-
straints that burden consumers, lower living standards, reduce competition and
threaten the world trading system. The United States has led the world through nearly
50 years of growth. More people in more countries have seen living standards rise by
larger amounts than in any previous period. The most favored nation principle that
started here in the U.S. Congress, and multilateral tariff reduction led by the U.S.,
were major forces producing this achievement.
Now, many in this same Congress want to turn back toward protectionist policies
that are costly to us and destructive of the rules of open trade. They urge policies that
are inimical to growth and that lower living standards here and elsewhere.
Much of the U.S. economy is in a strong, competitive position. Unit labor costs in
many industries have fallen far below comparable costs abroad. This is the time to
benefit our own economy and the world economy by adopting rules for freer and more
open trade and by strengthening enforcement through GATT.
Lower payroll taxes would encourage employment. A higher minimum wage and
more mandated benefits raise the cost of employing labor and reduce employment.
Avoid, the temptation to develop an industrial policy. The private sector is not al-
ways right, and the public sector is not always wrong. What matters is the batting av-
erage over years or decades. Be happy that you did not subsidize investment in the
Supersonic Transport, HDTV, the fifth generation computer and many other well-
advertised projects that were at one time or another claimed to be critical for our pros-
perity. Productivity growth occurs in both old and new industries. Steelmaking, tire
making, bread baking, and other industries are as capable of increasing standards of
living as the more talked about new industries. Beware of the Marxist fallacy, pushed
118
by proponents of protectionist policies, that progress is limited to the so-called "lead-
ing sectors".
The policies I urge on you are policies for growth and higher living standards, not
short-term stimulus. If you remove barriers to trade, avoid costly and burdensome
regulation of commerce and industry, encourage improvemei ts in the quality of edu-
cation for all, reduce taxes on saving and investing, and insist that the Federal Reserve
maintain the near price stability, that is now ours, growth and living standards will
continue to rise as they have throughout our history. And jobs will increase and oppor-
tunities expand, as they always have.
THE 1993 ECONOMIC REPORT OF THE PRESIDENT:
INVESTING IN PEOPLE
Thursday, February ii, 1993
Congress of the United States,
Joint Economic Committee,
Washington, DC.
The Committee met, pursuant to notice, at 1:00 p.m., in room 2359, Ray-
burn House Office Building, Honorable David R. Obey (Chairman of the
Committee) presiding.
Present: Representatives Obey and Wyden; and Senator Sarbanes.
Also present: Glen Rosselli, Charles Stone, William Buechner and Lee
Price, professional staff members.
OPENING STATEMENT OF REPRESENTATIVE OBEY,
CHAIRMAN
Representative Obey. This morning, I explained at the outset of our morn-
ing hearing that as the President is grappling with his final budget and eco-
nomic choices, at least the first chapter of which he will be presenting next
week, I thought it would be good if Congress could be examining some of
those same questions so that we can understand the complicated nature of the
choices available to the President. And I believe, as I said this morning, that
the best way to understand the problems that we confront is to recognize that
this country essentially faces four deficits.
It faces the budget deficit, which is well-known and often discussed. It
faces a growth deficit because our economy is growing much more slowly than
it has coming out of past recessions. Third, it is facing an investment deficit in
both the private and public sector, and the resuh of all of that has been, cer-
tainly, a family income deficit, with a tremendous squeeze being put on family
income — certainly over the last few years and, in my view, at least perspec-
tively, beginning in 1973.
To retrace what we said in this morning's hearing, I think this chart illus-
trates that, with respect to the federal deficit and the public debt which that
resulted in, we had a steady decline in the amount of debt as a share of annual
national income, during the years going down to about 1973. It then stopped
dropping in 1973 through about 1980, starting with the first oil shock in 1973.
And since 1980, as a percentage of our annual national income, our national
debt has just about doubled. (See chart below.)
It dropped down from over 100 percent of our annual income right after
Wodd War II, down to about 24 percent in the 1970s, and now it is back up
near 50 percent. We also have some specific impacts of all of these deficits on
income, and I want to get to these.
(119)
120
Debt Held By the Public
Percent of GDP
120
100
\
80
\
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\
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<u
o 60
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1993 estimate
\
40
N,.^^
y^^^
20
n
1945 1950 1955 1960 1965 1970 1975 1980 1985 1990
Source: Ottlce o( ManagemenI & Budget; Congressional Budget OHIce
This chart shows what has happened to real hourly compensation from
roughly 1958 through today. What this chart demonstrates is that if you take
all workers in the country and include wages and fringe benefits, we topped
out in 1980, and have been struggling along since then trying to move it up,
with not much success. (See chart below.)
Real Hourly Compensation
1982=100
1960
Source: Bureau of l^bor Statistics
1970
1980
1990
121
If you break this out a little bit and take a look only at the nonfringe benefit
direct wage compensation to everybody in the economy who is not a manager,
you see that average hourly earnings have declined from roughly $7.80 here in
1986 and 1987, down to about $7.45 today. I think that indicates what the
recent trend has been. The problem has been that this has not fallen equally
on Americans. (See chart below.)
Real Average Hourly Earnings
1982 Dollars per Hour Worked
$7.90
$7.80
$7.70
$7.60 -
$7.50
$7.40 -
1980 1981 1982 1983 1984
Source: Bureau ot Labor Statistics
This chart demonstrates what changes have occurred to people at various
income groups in terms of their share of national income. If you take a look at
the changes between 1980 and the end of the decade, you see that the poorest
fifth of Americans saw their share of national income drop by over 15 percent.
You see the second poorest share of Americans, whose income dropped as a
share of national income by 12 percent. The middle third dropped by around
7 percent. (See chart below.)
The second richest fifth, if I can put it that way, had a small drop. It is only
after you get to the 91st percentile in terms of income that you see that there
has been an actual increase in their share of national income over the decade.
It is only when you get to the top 1 percent that you have really cleaned up in
terms of what is gained or lost, given the way income has been redistributed in
the 1990s.
122
Change in Share of Income
by Income Group, 1979-1 989
60% -
-20% -
Bottom
Firth
Source: Joint Economic Committee
I remember in the 1980s that many people used to talk disdainfully about
income redistribution. By that they meant that they were offended because
income had been distributed down the income scale. As you can see, in the
last decade or more, we haven't had that problem. It has been just the reverse
— in the wrong direction, in my view.
I believe that in addition to all of our other economic problems, these prob-
lems are caused in large part because we have a real gap in what we are invest-
ing in comparison to what we should be investing.
This chart demonstrates that the average net investment as a percentage of
national output from 1946 through 1988 averaged a little above 6.5 percent.
As you can see, since the mid-1980s, it has really fallen off. (See chart below.)
123
Real Net Investment
Percent of Real Net National Product
1990
Soure«: Bureau ol Economic Analy3l*
If you take a look at just one small piece of that, our nondefense research
and development budgets, on a comparative basis with our main economic
competitors, you see that from 1970 through today, West Germany — repre-
sented by the blue line — has increased substantially their investment as a per-
centage of their national income. Japan has done the same — as represented by
this green line. Whereas, the United States has largely, with a small upward
climb here between, say, 1980 and 1981, stabilized at a level far below that of
our principal competitors. (See chart below.)
Nondefense Research & Development
Percent of GNP
3.2
3.0
2.8 -
2.6 -
c2.4
0)
u
o- 2.2
Japan
• • • • West Germany
2.0
1.8 -
1.6 -
1.4
• •%
\.
United States
■»■
1971 1973 1975 1977
Sourcs: National Sclencs Foundation
1979 1981
1983 1985 1987 1989
124
If you take a look at government investment, which is part of the investment
over which we have some control, as Members of Congress, you see that we
have had a tremendous change since 1980. This pie indicates that 36 cents out
of every dollar in 1980 went to the elderly and disabled through government
programs. Today, that is about 38 cents of every dollar, so that has grown by
two cents. If you take the share of the budget that went for the nonelderly
poor, that was 7 percent of the budget in 1980. By the end of the decade, it
had dropped to 6 percent of the budget, six cents on every dollar. (See chart
below.)
Shrinking Federal Investment
Investment 16%
Investment 9%
General Gov't 3%
Interest 9%
Economic Stability 5%
Non-elderly poor 7%
General Gov't 2%
Interest 14%
Economic Stability 4%
Non-elderly poor 8%
FY 1980
FY 1992
Source: Office of Manaaemenf & Budaet. Joint Economic CommitteG
Economic stability, unemployment compensation, and things like that, are
countercyclical to keeping the economy moving when it is sliding down, and
which you just continue when the economy increases activity — economic sta-
bility in 1980 represented five cents out of every dollar. Today it represents
about five cents of every dollar, so that has not changed much.
President Clinton announced yesterday that he is making significant reduc-
tions in the White House budget. To put that in perspective, we need to see
that the general government — which means what it takes to run the FBI, the
IRS, just to run the agencies of government — took four cents out of every dol-
lar in 1980. It was taking two cents out of every dollar by the end of the dec-
ade. So that had been cut in half as a percentage of the federal budget.
Defense, which was about 24 cents out of every dollar in 1980, was about
27 cents out of every dollar by 1990. It had been a little higher and had been
coming down by that time.
125
The two main changes that you can see here would be interest, which was
nine cents out of every dollar in 1980; by the end of the decade it was taking
14 cents out of every dollar, and it has changed a bit since then. And this is
the piece we are talking about today.
Direct government investment, and by that I mean investment in kids by
way of education, investment m health care — not health delivery, but health
research — investment in physical infrastructure, highways, the transportation
systems, the sewage treatment plants, the things that make a community func-
tion more efficiently; and the investments that we make in other direct areas
— in science, for instance, to try to stay on the cutting edge of technol-
ogy— that portion of the federal budget has shrunk from 15 cents out of every
dollar in 1980 to nine cents out of every dollar today, a more than 40 percent
drop.
And, in my view, we are not even going to successfully get the federal
budget deficit down unless we recognize the need to begin immediately rein-
vesting in the things that we need to be investing, in both the private and pub-
lic sector. And I know the President is looking at that, too.
This morning, we received some macroeconomic advice ft-om people who
were telling us what they thought the overall economic policy ought to be.
This afternoon we are going to be hearing from four people who will be telling
us what they think we can do to invest on the human side of the ledger. To-
morrow, we will be hearing from witnesses who will be telling us what our pol-
icy ought to be with respect to other kinds of investments.
I am very pleased that we have with us today, Ray Marshall, professor fi-om
the University of Texas, LBJ School of Public Affairs; and former Secretary of
Labor; and James D. WeUl, general counsel for the Children's Defense Fund.
We had hoped to have Bob Greenstein here, director of the Center for
Budget Policy Priorities, but he has been taken ill. In his place, we are pleased
to welcome Isaac Shapiro, senior research analyst, Center for Budget and Pol-
icy Priorities. We also have with us Richard Vedder, professor from Ohio Uni-
versity.
Let me stop at that point and ask Senator Sarbanes or Congressman Wyden
if they have any comments that they want to make before we proceed with the
witnesses.
OPENING STATEMENT OF SENATOR SARBANES
Senator Sarbanes. Mr. Chairman, I will be very brief. I am very pleased to
be here. I think this is a very important hearing which you have scheduled this
afternoon, following on the one this morning.
Obviously, the issue of people — as the President would put it, putting peo-
ple first — is a very important item on the American agenda; and I am pleased
to see this panel. Without derogating the other members of the panel, I do
want to say what a pleasure it is to see Ray Marshall before the Committee,
who was an extraordinarily effective Secretary of Labor, and has continued
through his work and his study to make a very significant contribution to the
betterment of our society.
Thank you very much.
126
OPENING STATEMENT OF REPRESENTATIVE WYDEN
Representative Wyden. Mr. Chairman, I will be very brief as well. I want
to associate myself with your remarks as well, because I think they were very
much on point and very timely.
I am particularly troubled about the increasing number of individuals who
are being laid off permanently, and I think we are seeing that in the downsizing
of major corporations — IBM, Boeing, Sears, General Motors. It is a particu-
larly clistressing trend, and one with great implications in public policy issues
before the Committee.
For example, one area that I intend to explore with Mr. Marshall, who I
know has studied the unemployment system at great length, is that the unem-
ployment system was really designed, I believe, to deal with essentially cyclical
unemployment — unemployment where, in effect, there was a downturn or a
business cycle that caused layoffs, and people at the end of the cycle get back
into the ball game and get good family wage jobs that could support the com-
munity.
What we are seeing now, however, is a trend towards a permanent downsiz-
ing, particularly seen in these very large announced layoffs; and that is why I
and others are very interested in exploring changes in the unemployment sys-
tem, so we can look to making that system a kind of trampoline, where citizens
can be at the conclusion of their unemployment self-sufficient.
I look forward to discussing these and other issues with our witnesses, and I
appreciate your leadership, Mr. Chairman.
Representative Obey. Thank you.
Secretary Marshall has to leave around 2:30 to catch a plane, so I am going
to ask each of the witnesses if you would summarize your statements as briefly
as you can, and then we may wind up asking Committee members to direct
what questions they have at him first so that he can leave and catch that plane.
If we go beyond that, then we will have time for the other witnesses.
Mr. Secretary, why don't you proceed.
STATEMENT OF RAY MARSHALL, PROFESSOR, UNIVERSITY OF TEXAS,
LBJ SCHOOOL OF PUBLIC AFFAIRS; AND FORMER SECRETARY OF LABOR
Mr. Marshall. Thank you, Mr. Chairman. Let me start by thanking you
for inviting me to share some ideas with you on this extremely important sub-
ject. I think your presentation has put our problem in good perspective, and
my remarks will be designed to enlarge on some of those comments.
I also beUeve that we really have a golden opportunity to make substantial
improvements in our economic policy, and to put the American economy on a
much sounder kind of long-run track. I, therefore, congratulate you and other
members of the Committee for your work here.
I think working with the Administration and the Congress can do a lot to
shape policies that will be of interest in the long run to everybody in this coun-
try, as well as in the world, because we need better economic leadership in the
whole global economy now than we have had, or that we are currently receiv-
ing.
Mr. Chairman, my remarks are based on a lot of work that I have done dur-
ing the 1980s. I have worked particularly with the commission known as Skills
of the American Work Force and the National Center on Education and the
127
Economy. The National Center has developed some recommendations on
human resource development for the United States, and with your permission,
I would like to leave this with you.
Representative Obey. Please.
Mr. Marshall. I didn't include it in my prepared remarks, except by way of
reference. I will say some more about this document because it outlines what
a group of us have been thinking pretty hard about all of our lives, but particu-
larly during the last half of the 1980s, and that was the origin of this, the rec-
ommendations we made to President-elect Clinton. In fact, we had made
many of them during the campaign.
I think one of the most important contextual understandings that we need
to have is why the recovery from this recession is as anemic as it is. In addition
to the policy problems, there is the fact that we are going through, in the global
economy, a substantial transformation in the requirements for economic suc-
cess. And that is particularly true of the United States.
If you ask yourself the question, how did the United States become the
world's leading economy by about 1926 — ^we did it very early — then I think the
answer is that there were essentially three things that caused us to be in that
position. One was, we had an abundance of natural resources when natural
resources were much more important than they are now. Natural resources
have become relatively unimportant for economic performance, and the main
reason for that is that technological change really means the substitution of
ideas, skills and knowledge for physical resources. And therefore, human re-
sources have become much more important; natural resources, much less.
The second thing that we had in this country was a large internal market
that made it possible to get easy improvements in productivity through econo-
mies of scale and through favorable inter-industry shifts, which raised the aver-
age level of productivity in the whole country. Scale was made possible
because we had the American market to ourselves, and therefore our compa-
nies could develop scale by dividing up the American automobile market, for
example, among three or four major producers.
And then the third thing is, we had supportive policies. I think it is a serious
mistake to underestimate the significance of public policy in causing our eco-
nomic success. These policies generally supported the growth of the mass pro-
duction economy — particularly the policies during the Great Depression — but
we also mass-produced students who were literate, and therefore made signifi-
cant contributions to the improvement of our productivity within the frame-
work of that kind of economic system. And we had the land grant college
system and the agriculture experiment station that significandy contributed to
the access of American agriculture.
Then we had the supportive poUcies of the 1930s and beyond, which were
basically designed to keep the system going. The value of that policy was dem-
onstrated during World War II when, in spite of most young males being in the
military and the United States being an arsenal of democracy, the average
American at the end of World War 11 was better off than when the war started.
This demonstrated to the world what a strong economic system we had.
A good bit of technology that we developed during the war was used to fuel
the postwar expansion and ushered in what is probably the longest period of
sustained prosperity, equitably shared in our history. And I think that was an
important accomplishment.
128
The thing that has happened, of course, is that the internationalization of
the system and technological change have transformed those advantages into
disadvantages. The fact that our mass-production system was so deeply en-
trenched meant that many of the institutions associated with it — Hke schools,
management systems in our companies and our public policies — have become
obsolete because we are now in a much more competitive, knowledge-
intensive world than ever before; and therefore the conditions for economic
success have changed, and the requirements of economic policy have there-
fore changed.
The choice we have in economic terms is pretty simple: You can either com-
pete by reducing your wages mainly, or you can compete by improving produc-
tivity, and there are no other options. We have been competing by reducing
our wages, and that is one of the reasons that we find that the only people who
are better off today than they were in the early 1970s are college-educated
people, and they are only 25 percent of our work force. Everybody else is
worse off.
Since 1987, college-educated real incomes are declining, and the only peo-
ple who are better off now than in 1987 are people with postgraduate degrees;
and that process, I think, is likely to continue.
A simple fact about tr>ing to compete with a low-wage strateg>' is that not
only will it cause wages to be lower and more unequal, but you limit your abil-
ity to improve your incomes to working harder, and there is a limit to how hard
you can work, and that is one of the reasons you get stagnation. If it were not
for more women working, family incomes would have declined along with real
wages, and we obviously cannot contain or sustain family income with more
women working. The slowdown in the growth of the work force means that
that option is no longer available to us, and therefore we will experience de-
clining real family incomes as well as real wages, unless we get productivity up.
Now, the advantage of the productivity option is that we don't know what
the limit to that is. See, we don't know what you can do, substituting ideas,
skills and knowledge for physical resources. We have done a lot of work to
demonstrate that that is the case. John Schultz, who works in Chicago and got
the Nobel Prize for returns of physical capital, demonstrated to some of his
students that we use fewer resources in agriculture now than we did in 1925,
and yet we have tripled and quadrupled output, depending on the product.
How did we do that? By using ideas, skills and knowledge. And that puts
you on a very steep earning and learning curve.
Peter Drucker uses an illustration that I think dramatically makes the point.
He points out that the seminal product of the 1920s in the mass production
system was the automobile, and the automobile was 60 percent energy and raw
material and 40 percent ideas, skills, and knowledge. He is talking mainly
about the Model T.
The seminal product of our day is the computer chip, and it is 2 percent en-
ergy and raw material and 98 percent ideas, skills and knowledge. And that
raw material is sand, one of the most plentiful products on earth.
Now, the problem with the high productivity strategy is that it won't just
happen. You have to have a strategy. We didn't have a big debate and decide
to go for the low-wage strategy; we backed into it by not having a strategy.
And therefore, it seems to me that we ought to try and build consensus that
that is the option that we ought to try and go for. And what that means is
129
having very different kinds of supportive policies now than the ones that we
had before.
We can no longer stimulate the American economy by what we do ourselves.
Therefore, we have to take a hard look at international policies and institu-
tions. We need global stimulus right now, but that is going to require a lot of
attention to those institutions.
We also need to establish a stable macroeconomic environment; and I sub-
scribe to the views of Bob Solow and Jim Tobin — I signed on as one of the
economists who supported their policies. It seems to me that in facing the im-
mediate and long-run economic problems that we face, we ought to do things
right now to increase investment, because that is the way we are going to have
a higher productivity strategy, and especially investment in our people.
It seems to me that if you look at the evidence of how you are able to get a
high productivity strategy, which most other countries have, first, you get sup-
portive policies — technology policies, macroeconomic policies, financial insti-
tution policies, trade policies. But after you do that, what you do with any
institution is that you pay heavy attention to the organization at work, as you
have to have lean, participative management systems, and we have demon-
strated that those can yield high productivity.
The second thing you need to do is to develop and use leading-edge tech-
nology. American workers will not be paid $10, $15 an hour doing the same
work on the same machines with the same skills that you can get done in Mex-
ico for a $1.50 or $2 an hour. And that means we have to have smart workers
and smart machines if we are going to be a highway to China in this country,
and therefore the last thing that you need to pay a lot of attention to among
that group is the education and training of your workers.
Now, where we are in the United States with that is way behind. A good
hypothesis about it is, how successful we are going to be depends mainly on
what we do for people who don't go to college, and we do very little for them.
We do more than anybody else for people that go to college, less than most
other industrial countries for people who don't, and we do almost nothing to
give them work-force skills. And I think that is a very important reality.
And a good, oriented hypothesis about it is, unless we pay attention to our
schools, to career preparation, to what happens to education and training on
the job, then we are going to be in big trouble.
The other main thing that I would emphasize about human resource devel-
opment strategy is that we need to do much more for our families and chil-
dren. The family is still the most important learning system. And we have a
larger proportion of our children in poverty than Japan or most West European
countries, and with some amazing exceptions, poor families are not very good
learning systems.
The good news is there is a lot we can do to help poor families be better
learning systems, for parents to be better parents and better teachers of their
children; and that is probably the best way to break the intergenerational cycles
of poverty that we have.
So the recommendation that we pay attention to is, we need to do things
about preschool, we need to do things about school. Let me say a bit about
that. Our schools were designed to mass produce literates for our farms and
factories in the early part of this century, and they still do that. They do not
130
turn out people with higher level thinking skills, and why don't they? Well,
mainly because we have no standards.
One of our recommendations is that you establish standards, benchmarked
to the best in the world, that all students are expected to meet. The value of
standards is that, first, you create incentives for students to work hard. In our
system, if you are not going to college, there is no incentive to work hard. It
doesn't make a lot of difference whether you take math and science or make
good grades or anything else. Having high standards would help with that.
Second, we need to provide incentives for teachers to teach in a very differ-
ent way, to restructure the schools — to have high-performance schools, just
like we need to have high-performance business organizations, producing en-
terprises. With standards, teachers know what they need to do in order to
bring students up to the standards.
It also would help a lot in providing information to businesses about what
the system does, and to give us some way to evaluate. We don't know how to
evaluate our schools. It is almost meaningless to say that we do it by SAT
scores or some pen and pencil test. A much better way to evaluate the schools
would be assessment tests, like the Scout merit badges, to see what you can
do; and for the process to be part of the learning process, not part of a screen-
ing process, to see what we need to do to help you meet the standards, not
whether we will cause you to flunk out.
The whole process of having standards that provide incentives is a part of
what we mean by high-performance organizations. Essentially, what that
comes down to is, you substitute standards and incentives for rules, regulations
and bureaucracies, and thereby greatly improve performance. The only way
that the traditional mass-production school can improve its performance is to
strengthen its weaknesses — that is, to add some rules and regulations and tests
— is ultimately self-defeating.
A second thing that we recommend is that we establish high standards for
people who are not going to college for noncollege occupations that are mod-
eled after apprenticeships, combining academic and work training. That is
what all of our major competitors do, and that is what we ought to do. We
found that only about 8 percent of the noncoUege-bound workers in this coun-
try get any kind of job preparation at all, and therefore this, I think, is the thing
that requires major attention.
I think we ought to remove the financial impediments for post-secondary
education. We erect stronger financial barriers than most of our major com-
petitors in going to college. Our recommendation is that you combine educa-
tional entitlement — I would go from the GI Bill concept — but if you can't do
that, then we go for a loan repaid as a surtax on your earnings, or repaid
through a national service program.
Next, we need to do more for education and training of people on the job.
We do a lot for people who have gone to college; almost all the expenditures
are more managerial, professional and technical training. We do almost noth-
ing for front-line workers, and the reason we don't is, the system is organized
to require little of them.
When we asked American companies, do you perceive a skill shortage, only
5 percent of them said yes. And the reason is because all they need are people
who are literate and will be disciplined, not people who are able to think.
131
We had German employers tell us they have quit selling their most sophisti-
cated technology in the United States because American workers couldn't even
learn to use that technology in a reasonable period of time. We have had peo-
ple go to Japan from the United States because they couldn't find people in
Texas with the education and learning skills required to use the most advanced
chip-making technology. So this is a serious problem.
Related to that, we need to give companies help in restructuring for high
performance. We need to have an industrial experiment station concept to
give technical assistance to firms, especially small firms that are unable to do
this on their own.
Finally, we need to have a labor market system in the country. We don't
have it. We have a fragmented, inefficient and stigmatized system. We need
to have a system of administrative boards at the federal level, at the state level,
and mainly at the local level. A person in the country ought to be able to go
into a local, highly computerized office and get counseling about jobs, train-
ing, financial opportunities, and that ought to be readily available to them.
You can make that available in shopping centers, housing projects, and every-
where. With modem technology, there is no reason that that couldn't be done.
Our competitors do that. But that requires that we establish a system, and we
recommend a system. And I think that would do, Congressman Wyden, for
the notion of what we need to do for the unemployed.
One of the reasons that people are unemployed is because they don't have
the skills for the new jobs, they don't have the means to acquire those skills.
We ought to have an adjustment program that would cause us to have an equi-
table sharing of the costs and benefits of change, and make it possible for peo-
ple to maintain their income while they acquire new skills.
For example, in most other countries — and particularly the Scandinavias
— if you are unemployed, your income continues, as it does in Germany; and if
they can't find you a job, they put you in a training program to upgrade your
skills so that they can maintain their competitiveness in improving productivity.
Now, how do we go about doing all that? In the human resources develop-
ment plan, we recommend, through the Clinton Administration — and we
would recommend it to the Congress as a way to go about it — that we ought
not to mandate that all the states do all this overnight. But what we ought to
do is to take a leaf out of the National Science Foundation book with their SSI
program and say, we are going to give 10 grants to states to take this design
and move with it, and there are some design requirements; we don't care how
you do it, you figure it out. And then the next year, we are going to take an-
other 10 grants, and the next year we are going to take another 10 grants. I
think, in that process, the states could shape programs to fit their own needs.
One of the requirements you would have is that you gain control of the Em-
ployment Service and make it part of the system; separate out the unemploy-
ment insurance component of that, and let this be a labor market and
education information system.
Another thing you have to do is to get some high-performance companies to
agree to work with you, because it won't just happen, because these stan- dards
for work need to be put together by labor, management and government work-
ing together to agree on what people need to know and to be able to do.
132
In conclusion, Mr. Chairman, I think it would be hard to think of a set of
policies that would be more important to our future than developing a coher-
ent human resources development strategy. Thank you.
[The prepared statement of Mr. Marshall, together with attachment, starts
on p. 160 of Submissions for the Record:]
Representative Obey. Thank you.
Mr. Weill, please proceed.
STATEMENT OF JAMES D. WEILL, GENERAL COUNSEL,
CHILDREN'S DEFENSE FUND
Mr. Weill. Thank you, Mr. Chairman. We appreciate the opportunity to
testify here today.
As you pointed out, much of the economic debate now going on in the
country centers on the deficit and on the size and scope of the forthcoming
stimulus package. These are certainly very important concerns. Our Nation
needs to attain and sustain strong economic growth again, and getting control
over the deficit is central to building and sustaining our long-term economic
health. But equally central to the long-term economic health of the Nation is
meeting the needs of our children and families.
As Mr. Marshall said, the economy now puts a premium on human re-
sources. Ill-fed, undereducated, unhealthy and increasingly alienated genera-
tions of children and young adults — future workers, parents and voters — will
not grow the economy, will not sustain Social Security's intergenerational
promise, will not maintain a strong defense, and will not nurture our democ-
racy, no matter how small the deficit is.
So what we have to do is to return to the human investment question, the
human resource question. I agree with most of what Mr. Marshall said today,
but I want to take a slightly different tack on the issue. We have to focus con-
siderably more resources on families and children if we want a strong and com-
petitive nation in the next centiuy, and we have to focus those particularly on
lower income families and children and on young families and children, the
youngest Americans.
I will touch briefly on four points.
First is the extent of child poverty in the Nation today; second, the harms to
children and to the Nation that our astronomical child poverty rates are caus-
ing; third, the particular economic problems of young families, which are driv-
ing and caused by many of these phenomena we are talking about; and fourth,
what we should do about it.
First, child poverty. Children, especially very young children, are now the
poorest Americans; they are almost twice as likely as adults to be poor. And
more than 14 million of our children, one in five kids and one in four pre-
schoolers, are poor. There are more poor children in America now than there
are citizens in famine -stricken Somalia. There are more poor children in
America today than in any year since 1965, even though our real gross national
product has nearly doubled since 1965.
And, as the Committee knows, contrary to the stereotypes, the majority of
this country's poor children are not black; the majority live in working families
rather than in nonworking families; and a majority live outside inner cities, in
small towns and rural and suburban America.
133
I want to make one other point about our high child poverty rates. Even if
we are beginning a major and sustained economic recovery, that will certainly
bring down child poverty, but it will not bring it down far enough or fast
enough. In earlier eras, some children fell into poverty during recessions in
this country, but larger numbers of them escaped poverty during recoveries. In
the last 15 years, this pattern has reversed itself. More children are falling into
poverty in each recession year than in earlier decades, and fewer children are
being lifted out of poverty during each year of recovery. Therefore, a full eco-
nomic cycle of recession and recovery now leaves more, rather than fewer, chil-
dren in poverty at the end of the cycle.
If the pattern of the 1980s, even with its number of strong growth years,
repeats itself in the 1990s, several million more children will be poor by the
end of this decade than were poor at the beginning of the decade.
My second point is that the astronomical rates of child poverty we have are
a tragedy not just for the children involved, but for the Nation as a whole.
Poor children are far more likely to die or be disabled and far more likely to be
hungry and, as a result of that, to suffer various illnesses and increased school
absenteeism. They are more likely to have below-average academic skills, fall
behind in school, repeat grades, and drop out. They are more Hkely to have
babies as teens.
Poverty also means more homelessness, more substance abuse, more crime
and violence, more racial tension and despair, and generally a long-term eco-
nomic and social disaster, not just for children, but for the economy as a
whole.
Third, much of the increase in child poverty, much of the sense among
American families of growing economic insecurity, and much of the economic
turmoil over the last two decades have been concentrated on America's young-
est families. Young families with children, those headed by persons under the
age of 30, have been devastated since 1973 by an unprecedented cycle of fal-
ling incomes, increasing family disintegration, and rising poverty.
Congressman Wyden has correctly pointed out that one of the most impor-
tant questions facing the Committee is what to do about the layoffs of long-
term employees hit hard by restructuring in major industries. Many of the
young workers I am talking about, representing an important and different and
new problem for this economy and for Congress, and a less visible one, never
got a toehold in the economy at all, never got significant long-term jobs in the
first place.
As a resuk, the total income of young families from all sources, even though
many sent a second worker into the work force — the total median family in-
come of these young families fell by one third from 1973 to 1990. In other
words, in less than a generation, the Nation reduced the standard of living of
those families that it should nurture the most — young families with young chil-
dren— by a third, while other families basically held their o-\^ti, and in the case
of families without children, grew wealthier.
As a result, poverty in young families more than doubled, and by 1990 four
in ten children with parents under the age of 30 were poor. Again, this poverty
doesn't fit, or just fit, the stereotypes. A generation ago our young workers, if
they were white or in a married-couple family, or as Mr. Marshall pointed out,
were high school graduates, were fairly well insulated from poverty. But the
economic damage of the last two decades for young adults has cut so broadly
134
and deeply that now one in four children in white young families, one in five
children in married-couple young families, and one in three children in young
families headed by high school graduates are poor.
My fourth and most important point and the reason we are here today is
that child and family poverty in America in the 1990s is not inevitable; there
are things that we can do about it. Indeed, the Nation can no longer afford to
have such widespread child poverty — economically, socially or morally.
The Nation now has more than adequate resources and the ability to con-
quer such poverty. Despite the picture that many would sketch of a Nation
totally crippled by budget deficits and without resources to tackle any of its
significant or fundamental problems, our income as measured by GNP will be
at an all-time high in 1993. It will be double what it was a generation or a gen-
eration and a half ago, far higher than in times when we were much more con-
fident that we could lick these problems.
The Nation's success in lifting older Americans out of poverty over the last
three decades should be a model, as should be our success in the 1960s when
we reduced child poverty by a half in less than a decade. We have compelling
evidence from our own history that we have the knowledge and ability and re-
sources to dramatically reduce poverty if we want to, and we also know that
from the experience of other nations. Our per capita GNP is equal to or
higher than that of most of our European competitors, but all of them have
lower child poverty rates.
We have to make better choices, and v/e have to start by targeting families
with children, and especially young families where the youngest and most vul-
nerable children are, for new and expanded benefits to give them the strong
foundation they need. CDF has recommended starting with those programs
that we all know work, where there is extraordinarily wide public support and a
consensus that public investments can make a difference.
The first two priorities that we have this year are Head Start and immuniza-
tions. In Head Start, we seek to guarantee full funding of the Head Start pro-
gram and an improved Head Start program that not only reaches all eligible
children, but better meets the needs of children of working parents. If we are
serious about the national goal of making all children ready for school, we have
to make good on our long overdue promise to give every poor preschooler
Head Start. And then, of course, we have to go on and meet the other na-
tional education goals.
The second area where we have an overwhelming consensus in this country,
as a basis for action, is on a highly visible campaign to get all American children
immunized. Right now, our immunization rates for preschoolers lag the rates
of many Third World as well as First World nations.
We are starting with Head Start and immunization because they enjoy such
wide support. They lay the groundwork for future success and focus help on
the youngest and neediest children. As Mr. Marshall has pointed out, public
policy has played a key role in building the U.S. economy over the past dec-
ades. One of the things we have to accomplish after the last couple of decades
is to restore people's faith in the efficacy of government, in the efficacy of pub-
lic policy. Head Start and immunizations are an important place to start, but it
is only the starting place.
135
There are a range of other cost-effective ways that we can build strong fami-
lies and attack child poverty, and create a work force that is able to compete in
the global economy in the decades ahead.
We can insure that our children and youth grow into healthy and productive
adults by including comprehensive coverage for them in any national health-
care reform plan that we enact this or next year, and by moving the WIC pro-
gram to full funding.
We must expand the Job Corps program, which has been extremely success-
ful, and launch a range — as Mr. Marshall has indicated — of new apprentice-
ship, community service and other training efforts.
We must rescue families in crisis and bolster the self-sufficiency of both par-
ents and children by quickly reenacting the Family Preservation Act, which was
passed last year by Congress, but vetoed as part of the Urban Aid bill.
And we have to insure that parents, and especially parents who work, can
support their families and lift them out of poverty. We made a start with the
Family and Medical Leave Act, and now we have to move toward expanding
the Earned Income Credit, toward regular adjustments in the federal mini-
mum wage, toward stepped up child support activity and creation of a child-
support assurance system, toward enactment of a refundable children's tax
credit for hard-pressed, low- and middle-income families, and toward a welfare
reform package that protects needy children while fixing the antifamily, anti-
work attributes of our current welfare system.
If we take these steps, we can grow the economy again, and we can attack
the problems that your charts showed so vividly, Mr. Chairman. These are the
steps that we absolutely have to take in the years ahead. Thank you.
[The prepared statement of Mr. Weill starts on p. 175 of Submissions for the
Record:]
Representative Obey. Thank you.
Before I proceed with the next two witnesses, what I would like to do is to
make certain that we ask Mr. Marshall a couple of questions before he has to
catch the plane. I would ask that each of the Committee members limit them-
selves to two questions to Mr. Marshall, and then get on with the other wit-
nesses.
Let me simply say that one of the things that bothers me — and correct me if
I am wrong — is that there is a stereotype about poverty. I think an awful lot of
people in this country feel that people who are poor are people who don't
work. But what strikes me is, as I look around the world and see conditions in
different countries, that we stand, really, in very stark contrast to most other
industrial countries, at least as I read the data.
If you take a look at a country such as Germany, for instance — or most any
other of our highly industrialized competitors — it is a fairly rare thing in those
societies for a person to be working full time and still be poor. Whereas in our
society, we have many people who are working and are still below the poverty
line. And I think that that has all kinds of implications for a lot of issues, in-
cluding education and training.
Let me ask you this, Mr. Marshall. You talk about the necessity to
strengthen education, to strengthen training, especially on-the-job employer
training. That doesn't deal as directly with the problem of people who are be-
yond normal school age, who lack skills to land the job that we have provided,
real training in the workplace. Sunday's Post had an article by Spencer Rich,
76-207 0-94—6
136
which took a hard look at government training programs to help those workers.
It suggested that effective training programs are very expensive. The Job
Corps, for instance, you remember Mr. Stockman tried to end that program
because he said it wasn't cost effective. He had people do studies to prove his
point. And the people that did the studies came back and said: Your point is
wrong; it is one of the most cost-effective job programs. People said, oh, gee
whiz, it only has a 40 or 50 percent success rate.
When you are talking about people who had zero success rate before that, it
seems to me that that is quite an improvement. There is a widely publicized
San Diego program for welfare recipients which raised income by 29 percent,
but only from $2,200 to $2,900. You are a labor economist. You inform the
Secretary of Labor. You must have researched the problem of improving skills
for post-school-aged, poorly skilled people with a special focus on those work-
ers, but not necessarily exclusively on those workers.
I desperately want to believe that if we do invest in education and training
that that will work. I would like to think that I am hard headed but soft
hearted when it comes to assessing whether things like that work or not. I
want to believe they work, but I have seen so many job programs undertaken
in the past which try to do it on the cheek, which try to provide a few weeks'
training and then shove them off into the job market for training, that you
know doggone well aren't adequate to meet their long-term needs, let alone
their short-term.
Let me ask you — because I think it is important if we are going to go down
this road with heavy emphasis on training — to make certain that this time
around we do it right, that we have a realistic understanding ahead of time of
what the cost is going to be per worker, and that we are prepared to meet that
cost if we think it is better and cheaper than the alternative. What exactly does
work, and what do we need to be prepared to spend per worker if we are going
to do anything other than fool ourselves that we are really engaging the prob-
lem?
Mr. Marshall. Well, I think that is a fair assessment.
Let me say that the evidence we have accumulated came from all over the
world. The Commission on Skills of the American Work Force, which I co-
chaired, studied the United States and six other countries in some depth. The
six other countries were Singapore, Japan, Denmark, Sweden, Germany and
L-eland. And we asked the question that you are raising. We did detailed in-
terviews in about 580 companies, 2,800 interviews; and we asked them the
question about education and training, and talked to a lot of government offi-
cials.
I think we have a pretty good idea about what kind of education and train-
ing works. We know that first you have to have the basic education skills
— and that is the reason we stress the standards for graduation fi-om high
school — that you need to be able to learn and to have a math background and
the fundamentals.
Now, the question is: What do you do if people don't have that? Well, what
we know from experience is that it is possible to have dropout recovery pro-
grams and adult education programs that can, very rapidly, bring people up to
those standards. I can cite you all kinds of examples of that. I have a book on
this with Mark Tucker called. Thinking For a Living, where we do look at the
experiences that people have with this, and we know that that is what you need
137
to do. Our recommendation is that you have those standards so that ev- ery-
body meets them, and not just for the people who are in school now. People
who are out of school can get involved.
What would you do with dropouts, who will probably be 25 percent of the
growth of our work force, during this decade? We recommend a dropout re-
covery program, modeled after the Job Corps Learning System, where, now,
with about 28 hours' instruction, you can move people 1.4 grade levels in read-
ing and one grade level in math. How would you pay for it.^ We would pay for
it by having dropouts stop subsidizing the public school system. See, schools
get their money on the basis of average days attended; and if somebody droos
out, the money stays with the school. So you don't discourage dropout. What
we would do is recommend that if a person drops out, if they have met the
high standards for graduation that we would establish, they be allowed to leave
the school and take their money wdth them to, say, a youth center that uses this
technology, and which we can demonstrate all over the country is achieving
remarkable success. So I don't think that we lack the means to do it or the
knowledge of how to do it. We lack a system to cause it to happen.
Now, I think you are absolutely right. All of our experience suggests that
good education and training is expensive in budget terms; but it also shows
that if you do it right, it is standards driven and meets the other requirements
for good training, that it is a high yield investment for whoever makes it. And
that is one of the reasons that companies do it.
We examined a German company that spent a lot for each trainee in their
apprentice program, like $9,000 or more a year for each one. They paid that
out of their own pocket. And when we asked, why do you do that, they said,
we have overwhelming evidence that we get back much more than we pay out.
And there have been studies comparing Germany, say, with Britain and with
other countries to show ... in fact, the German Economics Minister was asked,
to what do you attribute the success of the German system? He said two
things: One, we started late, and therefore we put a modem system in place.
I might add, we made the Germans do things we wouldn't do ourselves that
helped — which I think is the irony of it. I was in Japan, and we made the Japa-
nese do things; we taught them the system. They didn't invent that system full
blown. They did what made sense in 1945 and 1946.
And, then, his second answer was, almost every young German not going to
college gets into a well-structured apprentice program. They go to work, but it
is a systematic training process as well. By the time young Germans are 20
years old, they are skilled crafts people. By the time they are 25, they have
gone through the supervisor program, if they want to go to that; and the sys-
tem is open-ended.
If you want to be a carpenter and change your mind and want to be an ar-
chitect, you can do that; and you have all the requirements to do it because
you met the high standards, which is what I mean by the coupling effect of
standards. We waste a lot of resources in this country because we have no
standards. We spend the first two years of college doing what high schools in
most other countries do because we have no standards. By the time we spend
those two years, people are ready for college.
If we had standards, we could bring people up to a very high level. That is
the reason that we stress adult and worker on-the-job training, because if you
are going to be a high performance system, you have to continue to train.
138
Other countries do this. We don't. That is partly because we had this kind of
hierarchy called "management system," more deeply entrenched in this country
than it was in most other countries. And the whole idea behind that is that
workers don't have to think. Of course, that was a huge advantage, at one
point, if you were trying to increase productivity with a few skilled workers and
most people were just literate.
But if you are in a world today where all the workers have to have the same
kinds of skills that management used to have in order to give wisdom to the
machines, manage their own work, improve the quality and productivity them-
selves, and have a participating management system, our people can't do it.
That is one of the things American employers told us as reasons we can't do
what you are talking about.
One of the reasons is that all of the incentives in our system are to pursue
the low-wage strategy. If you shift this work into Puerto Rico or the Caribbean
basin, we get a subsidy for it. That is subsidizing a low-wage strategy. We
have uncertain economic policies. In addition to that, we have people who
cannot do the work, use the high level technology.
One of the most important and critical skills that you have is to be able to
impose order on information, or you can't make it in the kind of world we
have, because all the machines do is give us a lot of information. If you know
what to do, you can use it to improve whatever you do: You can be a better
Congressman; you can be a better teacher; you can run a better household;
you can improve the quality of the product and solve problems.
If you don't know what to do with it, it is worse than not having it. That is
one important skill. Another important skill, which our schools do not do a
very good job with and most of our learning systems don't have, is to teach
people how to learn. It is a surprising thing. We have learned more about
learning in the last 10, 15 years than in all of our previous history. Yet, very
few of our schools pay much attention to what we have learned about how
people learn.
Fortunately, the model of how people learn, which is almost tailor-made, is
the apprentice program. There is the combination of on-the-job learning and
academic work. Now, we don't have to have everybody be in a formal appren-
tice program, but we think you can make that kind of technical training avail-
able to everybody and they can benefit from it.
T^ain, you have to have standards, because the industry people have to say,
what do we want workers to know and be able to do? And we found that
workers in other countries — tellers in banks, for example — can do a whole lot
of things that our people cannot even come close to doing. They are financial
consultants; they are in insurance, and all the rest. Our people have no abiUty
to do those kinds of things, and therefore improve productivity.
So I think that while it will be expensive, it is a good investment. And I
think it is the best investment that you can make, and we have a lot of evi-
dence for that — international as well as here.
I think the other myth that we have to overcome about aduhs, as well as
kids, is that some people can't learn. That is one of the things we have learned
about learning. Learning is mainly due to supportive learning systerns and
hard work and has very little to do with genetics. Therefore, you can take
these kids — I'll put a plug in for the Job Corps, because it was one of my favor-
ite programs when I was Secretary of Labor — we found that about 25 percent
139
of the high school graduates coming into the Job Corps were illiterate. But the
system that was developed in the Job Corps made it possible, ver\' quickly and
in an interesting way, for those young people to get high school level skills and
some job skills. I think that model is one that we ought to learn from and use
more than we do. I think we ought to require companies — that is another one
of our recommendations that is most controversial — to satisfy at least 1.5 per-
cent of payroll for the education
Representative Obey. That's what I wanted to get into with you. Since I
believe that most of the best training is going to take place in the workplace by
employers and not directly by the government, the question is how you get
people to meet their responsibilities without being a free rider.
I visited a small business in my hometown in Wausau, Wisconsin last year,
where a friend of mine, who runs a small business, told me that he has a policy
which uill pay for whatever education and training his workers want, up to and
including four years of college. Up to that point, he had never lost a worker.
Now, I don't know if there are many employers who are willing to go down
that road; but people say, how can somebody like that do something Hke that,
because then somebody else can come along and hire the guy and get the
benefit of it.
One of the arguments you used was against those who say we should not
assess corporations a certain percentage and then rebate it to them if they meet
a proper level of job training requirement.
Mr. Marshall. We had a big debate on this. As you perhaps know, I co-
chaired with Bill Brock the Commission on Skills of the American Work Force,
and later Hillary Clinton became cochair. The Commission was unanimous on
that recommendation. We looked at all the alternatives, and one of the main
arguments that drove the system was, first, we see that it needs to be done.
We are not going to solve the problem in the country by trying to just fix the
schools. And we are not going to become competitive in international markets
unless we see to it that our people are much better educated and trained than
they are now.
One of our rules was that nobody recommend an>thing until we agreed on
the facts; and when we got all the evidence in, everybody agreed to it and then
said, well, how do you get it done? What economics tells us is that a rational
employer will not pay any costs that they don't have to. And that is what we
have done in the country. We have actually bid people away from other coun-
tries; but now that our wages are no longer the highest in the world, we are
going to have trouble with that. Companies bid away from other companies,
and we have to find some way to eliminate the free ride. At any rate, it seemed
to us that the most painless way to do it would be to spend at least 1 percent.
During the campaign, President Clinton said 1.5 percent. I think the majority
of our Commission would have supported 1.5 percent. But now I know that
you would get some political opposition to this.
So my recommendation is to turn to the business community, if they don't
like this, and say, you see the problem; what would you do? That is what the
Germans did. One of the reasons the Germans pay for all this themselves, first
the experience forced them to see that it was a high-yield investment, and
therefore a good thing to do; but, second, if we don't do it, the government
will make us do it.
140
Well, if we had some way to cause American businesses to avoid this free
rider problem, what we would do is not just use that money for education and
training. The Swedes have what they call renewable funds, which makes some
sense. That is, use it to help pay for this extension service idea that helps small
business with their education and training programs. It seems to me, if they
are going to benefit from people being well trained and well educated, then we
have a right to expect them to help pay some of the costs of doing it. Other
countries do this. There are various ways you can arrange it. We like the so-
called levied grant system. You don't pay it unless you do it.
We found, on average, companies already spend about 1.4 percent. We did
the work. So you weren't calling on people to do a lot, you know, that wasn't
already being done, and if you had some standards for it — ^which is the other
reason to keep stressing the standards — I wouldn't let them just do whatever
they wanted to do. They have to be moving towards some standards. Then
they get back, I think, more than they paid. They might not believe that up
front, but I believe they would in the end.
All the evidence suggests that that is, in fact, the case. One of the reasons
the Germans turned to the system that they now have is that they looked at the
evidence from our GI Bill, which showed that the Federal Government got
back from the World War 11 GI bill a substantial return above what it cost
them. If that is the case, if the returns are as large as is suggested by that evi-
dence, then you lose a lot not making that investment; and that is the conclu-
sion they came to. I think that is one of the reasons they really believe what we
say we believe. They believe their people are the most important asset. We
say that, but we sure don't act like we believe it; or we wouldn't treat children
the way we treat them in this country.
The German employers have a concept that they call "social market econ-
omy." We have to be responsible for them, investing in our people and pre-
venting poverty, giving health care to people, immunization and training. That
doesn't cost us anything. It only costs you something if your mindset is for the
low-wage development strategy. Then you see it as a cost and not as an invest-
ment.
Representative Obey. Thank you very much.
Senator Sarbanes.
Senator Sarbanes. Thank very much. I was wanting to ride along with this
discussion.
Do you think there is a significant difference between the training provided
by the public sector and training obtained in the private sector by the em-
ployer?
Mr. Marshall. Yes.
Senator Sarbanes. Suppose you said, well, we are going to do the training
through the public sector, as opposed to having each employer do on-the-job
training. Is there a significant difference in achievement?
Mr. Marshall. I think that it ought to be a combination, if you are talking
about job training. That is, there ought to be a partnership between the public
and private sector. The private sector knows what kind of people they want.
They ought to help set the standards.
There are some things you can do better in a classroom setting, whoever
runs it; and other things you can do better in a job setting. It is hard, in most
classroom settings, to reproduce the workplace. Therefore, the workplace is a
141
good place to learn those things. You also get motivation because people can
see what they need. That is one of the things we have learned about learning,
and it seems to me to be less the question of whether it is public or private.
I don't believe, for example, with respect to schools, that there is any credi-
ble evidence that private schools are better than public schools. We deal with
that in Thinking for a Living, as well. Once you look at all the evidence, you
don't see that. I think what you do is a lot more important than whether it is
public or private. And I think that's a legitimate role for the public sector to
set.
I would say that one important public function is to create incentives for
companies to do what is in their interest and in the national interest. Evidence
suggests that they won't automatically do what is in their long-run interest if
they have a short-run orientation.
Senator Sarbanes. That is what I want to pursue, because the next ques-
tion I want to ask is, is there a big difference between large employers and
small employers?
Mr. Marshall. Yes. Almost all of it is done by large employers, except in
industries like construction.
Senator Sarbanes. Here is what the employers, who are not doing it, say: If
you throw this burden on us, it is the burden that will break our backs. We are
close to the margin, but it is a worthwhile goal; it is a laudable goal; we agree
with that. But we just can't find the wherewithal with which to do it. We are
right at the margin and if you require that of us, we can't handle it. That is one
argument we get. I would like to know your answer to that.
The other argument — which I am not exactly clear on how you are going to
get at it, particularly if you give any credibility to the point I just made — is how
you avoid the cherry picking for some, where some employer does all of this
stuff, and then somebody else comes along and he bids away his employee.
Not having had to incur the cost, he can offer him a somewhat better employ-
ment package. So they find this person they have invested in and trained, who
goes marching off somewhere else, gets a short-run windfall.
Mr. Marshall. I think that is a problem, which is one of the reasons we
recommend the levied grant project, that everybody has to pay, not just people
who are doing the training.
Senator Sarbanes. In order to do that, how do you get over the first prob-
lem that I indicated to you?
Mr. Marshall. My view about that is that it is probably exaggerated. If you
were at the margin and the only way you can operate is to raid workers away
from other companies, my view is, you ought to go broke and cave in. What
the society ought to do is to try and take those workers during an adjustment
program and shift them into a company that can pay for the education and
training of their front-line workers, and therefore be world class.
The reason I say that, if you don't make companies cover costs, you are sub-
sidizing inefficiency. An efficient firm is the one that can operate by paying all
of the legitimate costs — including environmental, worker training, worker stan-
dards— and make a profit. If they are unable to do that, it seems to me we
ought to discourage them.
Senator Sarbanes. Do you think we have an attitude problem that compli-
cates this, compared to other countries; namely, the objective is to go to col-
lege.
142
As you pointed out, only 25 percent, roughly, of our people go on to college.
We have 75 percent who are not doing that, and yet we failed to attach any
status or premium to developing high skills and high wages, which are achiev-
able even without an actual formal college education —
Mr. Marshall. I think there is no doubt at all that we are among the most
elitist people among the industrialized countries in our attitudes about work-
ers. It comes from Taylorism. That is what the management system taught us,
that only college-educated people could understand the science of work.
The status of a skilled worker in Germany or Japan is substantially higher
than it is here, and they value that. And one of the ways that they eliminate
the distinction is they make the apprentice open-ended. That is, if you make
the requirements, if you go through the apprentice program, you can go to the
university if you want. And there is no reason why we don't do that, but you
have to have the standards. You have to have the learning and thinking skills
to go on and do that. And the same thing with, I think, the attitude of man-
agement when they allocate the training within the company. They are likely
to spend it mainly on managerial and professional training.
Senator Sarbanes. We don't have it here, but we have a chart we use on
this Committee which shows, compared with the Japanese, how much they put
into training their employees and how much we do; and there is a gap at every
level. But we are closest in training college -educated people. We are still less
than them, but we come closer. As you move back from the college educated,
the gap grows very significantly, and our companies do far less for the less than
college-educated people, in terms of their own training programs, than the
Japanese do. Ours is very heavily loaded to the more highly educated part of a
company's work force.
Mr. Marshall. That is right. Of course, one of the big differences between
what employers told us is that most employers in other countries, even though
they had high standards and better educated front-line workers — said they per-
ceived a skill shortage. Very few American employers said they saw a skill
shortage. Bill Brock said that is the good news and the bad news. The good
news is that the schools can turn out the kind of people they want. The bad
news is that they plan to keep on competing for the mass production, low-wage
strategy, and therefore are not likely to restructure. And I think unless we
cause it to change, they are not likely to.
Senator Sarbanes. Thank you very much, Mr. Chairman.
Representative Obey. Congressman Wyden.
Representative Wyden. Thank you, Mr. Chairman.
Mr. Marshall, you make so many good points. I particularly like your analy-
sis that puts a special focus on the difference between the skilled worker and
the unskilled worker, and the challenges we are going to have in that regard.
Let me ask you first about the unemployment system. One worker de-
scribed it to me as, essentially, being economic methadone for him. He said
they gave me my check; I get it on a weekly basis; but I won't get anything out
of this program until I can eventually get out on my own.
My sense is, with this downsizing that you and others have talked about, we
are now going to be turning out more individuals from these large companies
who honed skills over a period of 15, 20 years, who could go out and use those
self-employment programs. So the unemployment program could, in effect,
143
become a trampoKne, so at the end of it they could get out and be self-
sufficient.
Is it your sense that in the downsizing of the people who are being perma-
nently laid off, we are now going to have more of those individuals with real
skills and creative abilities, who could use this unemployment system in a new
way?
Mr. Marshall. I think that is right. And I think we ought to learn from
logic, as well as what some of our competitors do.
If you were in Sweden or Germany, for example — Sweden especially — the
last thing they would do for you if you were unemployed is just pay you the
dough. They call it unemployment compensation.
First thing they do is to assess your skills through one of these offices that I
think we ought to have, and then they would say, well, we have a job for you
someplace, and they would help you go and find out about that job. Or they
would say, look, if you want to keep on earning the income you have been
earning, you are going to have to get some more skills. You have a good bun-
dle of skills, and they are not hard to identify in a set, but you need to get
these others. We have a program you can get into, and here is how you pay for
it. We will maintain your income maintenance if you will get into that pro-
gram, but if all you are going to do is just draw unemployment compensation,
you are off the dole. Some people would say that is harsh; nevertheless, it is an
effective way to do it.
Now, it seems to me that with our modern information technology, if we
organize a system effectively, we could tailor a program for the individual
worker. I would do that. I would have the employment service spend a lot less
time through this amiable fixation we have, that people are looking for work,
which encourages fraud. The assumption is that we are dealing with cyclical
downturns. In American industry, we use the unemployment compensation
■ system as a wage substitution as a way to retain our work force during the
downturns. Everybody thought they were going back when the cycle picked
up, so they didn't really look for another job in some other place.
Now, I think that is not our main problem. Our main problem is to con-
tinue to see that people have the skills, information, to be able to move into
jobs that are available if you have the skills, get a better match between the
skills and the jobs. And I think we ought to do that and we can do that.
Representative Wyden. I want to ask you another question, but I also want
to tell you, I very much appreciate the approach you take by trying to take a
block of states at a time to do this. The self-employment law, which I
authored, has expired. We are going to extend it now, but the success that we
saw in Massachusetts and Washington ought to be extended to other states.
And your idea of trying to go to a block of states at a time makes sense.
Mr. Marshall. I agree with that. I didn't comment, but I think the big
thing is not a job; it should be a career and an income-earning opportunity.
Representative Wyden. Let me see if I can get one other question in real
quick. I know you have to get a plane.
You talk about the challenge in terms of the global economy — and it is one
that I have heard Senator Sarbanes talk eloquently about, as well — ^we are
probably going to be faced with the North American Free Trade Agreement,
the next concrete case of exactly what kinds of approaches we ought to use in
terms of labor, training, and the like.
144
Could you capsulize on a couple of the ideas that you would think would
make sense for the agreement that President Clinton has perceived.
Mr. Marshall. I think the guiding principle ought to be to encourage both
the United States and Mexico to pursue a high-wage strategy.
Now high wages doesn't mean Mexican wages equal ours. It means that
your objective is to maintain and improve your income. And that is a high-
wage strategy.
The alternative, which is what the North American Free Trade Agreement is
designed to do now without the side agreements, is that you don't try to narrow
the gap by raising Mexican standards; you try to narrow the gap by lowering
U.S. and Canadian standards. And I think that would be a huge mistake to
try and do that.
The European Community has taken the opposite view. They are trying to
bring the Greek, Portuguese and Spanish wages up to the German level. Now,
you don't do that overnight. So I think that is the first thing, is what the guid-
ing principle ought to be. And I believe that would do more to improve rela-
tionships between countries than almost anything you can think of.
The wage competition is what the "begger thy neighbor policy" was during
the 1930s. It will generate friction between countries. Everybody pursuing the
high-wage strategy will adopt it. Nobody is going to get mad at Mexico for
improving the productivity of their people and improving their education and
training of their people. But we are going to get mad if American companies
try and escape to Mexico in order to avoid meeting legitimate labor standards
and environmental conditions in this country.
I think the labor and environmental standards — and I have spelled that out,
and would be glad to share with you a paper I have done on that subject — will
encourage efficiency, mainly because you cause people to compete by improv-
ing productivity and efficiency, not by reducing labor standards.
Then we need to, I think, do some things called a multinational basis to help
Mexico with technical assistance if that is the case, or for them to help us. In
some cases, their standards are higher than ours on paper. They don't enforce
them, but on paper they have some pretty good standards.
I think you can get into a big argument about whether you are going to cre-
ate jobs in the United States or cost jobs. Nobody thinks it will create many,
not even the most optimistic proponents of the NAFTA believe that. It is mar-
ginal at best. And I believe you will have substantial displacement and loss of
jobs, and that it will contribute to a widening of the income gaps in the United
States. It will perpetuate that process. But since we don't know, why don't we
erect some safeguards? Why don't we see to it that the agreement is really in
the best interest of the United States and Mexico? It is in our interest for
Mexican workers to improve their conditions. It is in our interest for Mexico
to develop a stable, democratic and prosperous system. They are not likely to
do that, in my judgment, without some external help. It won't automatically
come from the NAFTA. I am convinced of that, and the market won't do it,
and didn't do it for us. We didn't pass OSHA until 1970, and we had been
developing a long time before that took place, so I think that we need to erect
the safeguards, try to see to it that that agreement is mutually beneficial as the
proponents claim. I don't believe it will be without strong environmental stan-
dards.
Representative Obey. Thank you, Mr. Secretary. I know you have to leave.
145
Mr. Marshall. Thank you, Mr. Chairman.
Representative Obey. I appreciate you coming.
I apologize to the other two members of the panel, Mr. Shapiro and Mr.
Vedder, for the bifurcated nature of this hearing, but now that Ray is on his
way, why don't we continue with Mr. Shapiro.
STATEMENT OF ISAAC SHAPIRO, EXECUTIVE DIRECTOR,
CENTER FOR BUDGET AND POLICY PRIORITIES
Mr. Shapiro. Thank you. I actually did have to restrain myself from jump-
ing in right after your first question to Mr. Marshall, because it is the topic of
the working poor that my comments will specifically address. My statement is
based largely on a forthcoming report on the working poor that I am co-
authoring with Bob Greenstein, the Center's executive director.
Investments in education and training will fully pay off only if improvements
are also made in the returns to work for low-wage employees. The wages of
the typical nonmanagement worker, as you noted, have been falling for some
time, and the problems of the working poor have been rising. A better pre-
pared work force can help reverse these trends, but direct steps to reduce
wages are needed as well. I will focus my remarks on two such steps, increases
in the Earned Income Tax Credit and minimum wage.
The problem of eroding wages is particularly acute for low-wage workers. A
recent Census Bureau report found that between 1979 and 1990 the propor-
tion of full-time, year-round workers who were paid wages too low to lift a
family of four to the poverty line increased dramatically. Of note, the report
found that the proportion of workers with low earnings rose about two-thirds
for workers of all educational backgrounds. This underscores how better train-
ing and education will not by themselves address the wage problem and, in-
deed, as you noted, Mr. Chairman, how the working poor remain a disturbing
social problem.
In 1991, an estimated 20 million people, 56 percent of the poor, lived in
households where someone worked during the year. An even larger share of
poor families with children include a worker. Indeed, 5.5 million people live in
poor families with children, which includes a member who worked full time,
year-round.
To address the problems of the working poor, there has been growing sup-
port for the goal that work should pay sufficiently so that if you work full time,
you should not be poor. President Clinton is among those who have expressed
emphatic support for this goal.
The reform agenda for achieving this goal is wide ranging, but two of the
most important policies are the Earned Income Tax Credit and the minimum
wage. The refundable Earned Income Tax Credit is strongly pro-family and
strongly pro- work. It is provided only to low-income parents who work and
Uve with their children.
Moreover, EIC benefits increase with each additional dollar earned by the
very poor. Consequently, the EIC strengthens the incentive to work for those
working little or not at all. To obtain these benefits, families simply must file
income tax returns. The Earned Income Tax Credit was expanded sharply in
1990. This expansion will take full effect in 1994. In that year, the maximum
basic credit will be $2,000.
146
The minimum wage, in contrast, fared poorly during the 1980s. It remained
at $3.35 an hour, from January 1981 through March 1990, when legislation
raised the wage floor in two steps to its current level of $4.25 an hour. These
increases made up less than half of the ground lost to inflation during the
1980s. In fact, if the value of the minimum wage were to have the same pur-
chasing power today as it averaged in the 1970s, it would need to be $5.42 per
hour.
In addition, in the 1960s and 1970s, full-time work at the minimum wage
usually lifted a family of three above the poverty line. By contrast, in 1993,
full-time minimum wage earnings will leave a family of three 23 percent below
the poverty line. In fact, the minimum wage is now so low that a family of
three, with a full-time minimum-wage worker, remains below the poverty line
even when the EIC benefits are added in. Full-time minimum wage earnings
plus the EIC benefits minus payroll taxes leave a family of three $1800 below
the poverty line. Since the poverty line rises with family size, the net income of
a full-time minimum wage worker falls $5,100 below the poverty line for a
family of four.
If the combination of minimum wage earnings plus the Earned Income Tax
Credit is to lift families out of poverty, these policies clearly need to be
strengthened. Moreover, it is imperative that policy reforms not rely too heav-
ily on one policy instead of the other.
The two policies are best viewed as complementary approaches for several
reasons. The first reason is that the cost of the EIC expansion necessary to
meet the goal that families with full-time workers escape poverty is exception-
ally sensitive to the value of minimum wage. Without some increase in the
minimum wage, the cost of the EIC expansion to the government is likely to
be several billion dollars larger. The cost of the minimum wage expansion is
borne by the private rather than the public sector.
The targeting of the proposals also complement each other. The EIC is bet-
ter targeted to the working poor families. At the same time, however, mini-
mum wage benefits poor, single individuals and childless couples, while the
EIC does not.
In addition, most poor workers do have earnings at or near the minimum
wage. Relying solely on expansion in the Earned Income Tax Credit is also
unwise because it would further increase the already high marginal tax rates in
the income range over which the EIC is phased down. Since the minimum
wage does not phase down as income rises, a higher minimum wage does not
raise marginal tax rates.
Finally, virtually all EIC recipients receive the credit in one annual lump
sum payment, while the minimum wage is delivered in every paycheck.
In short, the EIC is better targeted, while the minimum wage delivers its
benefits on a more timely basis without raising marginal tax rates. If the EIC is
relied upon too heavily, the public costs are likely to be very high, but a combi-
nation approach results in the sharing of costs between the public and private
sectors.
While expanding the EIC has received widespread, bipartisan support in
policy circles, expansions to a minimum wage have proven more controversial.
The potential effect of a minimum wage increase on employment has, of
course, been the principal argument raised in opposition to such an increase.
The argument is made that a higher minimum wage would price a large
147
number of young workers out of the labor market. While the potential em-
ployment effects of a minimum wage increase do deserve consideration, the
weight of the empirical evidence suggests the effects are likely to be modest.
One recent analysis updated the single best study of the effects of the mini-
mum wage during the 1960s and the 1970s. The new study used information
through 1986. The update found the minimum wage has a very modest effect
on teenage employment. It also found that there was no significant relation-
ship between the level of the minimum wage and the level of emplojTnent of
young adults or older adults.
Moreover, studies by some of the Nation's leading labor economists of the
impact of increases in the minimum wage in 1990 and 1991 have found it did
not reduce employment.
David Card of Princeton University examined the effects of the minimum
wage increases on states with differing proportions of low-wage workers. He
found that the wage increases boosted incomes, but did not negatively affect
employment, even among teenagers.
Another notable study of the impact of the recent increases in the minimum
wage was conducted by Larry Katz and Alan Krueger. Their findings were
similar to Card's. They also found that the minimum wage increase had no
effect on inflation.
These studies do not suggest that any increase in the minimum wage, no
matter how large, would have only desirable effects, but they do suggest that
when the minimum wage is set at especially low levels, as it is today, the em-
ployment effects of a change in the minimum wage may be modest.
How should the EIC and minimum wage reforms be structured? To
strengthen the Earned Income Credit, one necessary step is to adjust it more
adequately by family size.
The EIC now has two tiers, a basic benefit for a family with one child and a
benefit about $160 a year higher for a family wath two or more children. The
$160 annual increment is far smaller than the increased income needed for an
additional child. A restructured EIC could include a third tier of benefits for
families with three or more children.
As far as changes to the minimum wage, the Wall Street Journal recently re-
ported that:
Labor Department officials are expected to push for an increase of as
much as 10 percent in the minimum wage and then index it to inflation.
The article then went on to describe how business groups are gearing up to
oppose this presumably large increase in the minimum wage. The article did
not include any context in which to judge the resulting value of minimum
wage. It turns out that an increase in the minimum wage of 10 percent would
simply return its purchasing power to that achieved on April 1, 1991, when the
minimum wage was last raised. This was the value agreed to by President
Bush. He vetoed a higher level.
More importantly, even with the 10 percent increase, the minimum wage
would remain well below its traditional level of support. Its purchasing power
would remain 16 percent below its average during the 1970s. If the minimum
wage is to be restored to a level closer to its historic value and in order to get
closer to the goal that all families with full-time workers should not be poor, a
real increase of more than 10 percent is appropriate.
148
Such an increase should be spread out over several years in order to ease
labor market adjustments. The first increase should also be moderate enough
that it does not interfere with an economic recovery. Once the target level is
achieved, indexing the minimum wage would allow for small, steady changes
that labor markets should be able to absorb.
In a final note, I would like to discuss one particularly important investment
in children, and that is the need to fully fund the special supplemental food
program for women, infants and children. A recent study by the General Ac-
counting Office found that each dollar invested in prenatal WIG benefits
saves nearly $3 in costs within the first year after birth, and even more down
the road.
The payoff for WIG funding is the main reason why the program receives
strong support among key business leaders, among both Republicans and
Democrats in Gongress, and by President Glinton. It has also led to wide-
spread support for fully funding of this program so that it can serve everyone
who is potentially eligible for it. Expediting the full funding of WIG merits
consideration in the economic stimulus package.
The program has an exceptionally high spend-out rate, meaning that an ad-
ditional dollar spent on the program will put money into the economy quickly.
The desired long-term expansion of WIG could simply be front-end loaded at
no additional long-term cost.
Thank you.
[The prepared statement of Mr. Shapiro starts on p. 183 of Submissions for
the Record:]
Representative Obey. Thank you.
Mr. Vedder, please proceed.
STATEMENT OF RICHARD VEDDER, PROFESSOR OF ECONOMICS,
OHIO UNIVERSITY
Mr. Vedder. Thank you, Ghairman Obey, for inviting me.
There has been a great deal of similarity in the comments made today. Let
me, in the interest of diversity, offer a different perspective on some of these
issues, although I would say that I do agree with Secretary Marshall and some
of the others on the importance of productivity, on the needs for standards
with respect to education and other things.
First, let me speak briefly about job opportunities. What can be done to
reduce unemployment?
I am an economic historian who, with my colleague, Lowell Gallaway, has
recently written a book. Out of Work: Unemployment and Government in
Twentieth-Century America, which was published by the Independent Institute.
Our examination of 90 years of American employment history suggests that
jobs are created in greater numbers when market forces are allowed to operate
without substantial governmental interference.
Moreover, the greatest periods of high unemployment in American history
were largely attributable to well-intended interventions in the labor market that
led to wages for workers being pushed above a equilibrium level consistent
with full employment.
Labor will be hired when the price is right. Like virtually anything else,
more labor is hired when it becomes cheaper.
149
The law of demand works in labor markets just as it works in the potato
market. Any government effort that tends to increase the cost of labor will
tend to reduce job opportunities for American citizens.
For the past several months, what Gallaway and I caU the adjusted real wage
has been falling. Moderate wage settlements, combined with rising labor pro-
ductivity, have reduced labor costs per dollar of sales, which is beginning to
lead to greater demand for workers.
Since June, the unemployment rate has fallen at least one fourth of the way
back to its long-run sustainable rate, and my reading of the statistics on wages,
prices and productivity leads me to believe that the unemployment rate will be
down to 6.5 percent by this summer without any intervention. Thus, without
any special governmental policy, unemployment will have fallen about one half
of the way back to normal, from its recessionary high in a period of about a
year.
I am somewhat concerned, however, that the recovery could be disturbed by
well-intended policies that tend to raise labor costs and thus lead to reduc-
tions in employment. It has been mentioned that Labor Secretary Reich is on
record for favoring increases in the minimum wage, including changing wages
in the economy.
I would suggest that the sharp increase in the minimum wage in 1990 and
1991 contributed importantly to the rise in the adjusted real wage at that time,
which brought on the 1990 recession. The tragedy of minimum wage interven-
tion is that the burden of unemployment that is generated falls largely on the
young, the unskilled, and members of minority groups. The burden falls on
those least able to afford it.
Other proposals, discussed during the campaign or since, would have similar
negative effects. Banning the hiring of replacement workers in strike situations
reinforces wage rigidities and collective bargaining agreements that they im-
pose— rigidities that tend to prevent markets from alleviating joblessness. A
training tax to finance worker training likewise would increase labor costs per
dollar of sales, leading employers to reduce hiring.
Extending unemployment insurance benefits further, already at a historic
high with respect to duration, would raise what economists call the reservation
wage, reducing job growth in months ahead. Similarly, proposed increases in
the taxes on income would reduce the quantity of labor supply.
I think it is no accident that the creation of 5,000 jobs a day during the
1980s occurred after the time when changes in the tax code increased the
spirit of enterprise in the work efforts of Americans. A similar job boom fol-
lowed the enactment of John F. Kennedy's tax cut in the 1960s.
Most jobs are generated by small business, and the boom in jobs in the
mid-1980s can be attributed in part to a favorable regulatory environment to-
wards small business, while the sluggish job growth during the last several years
can be at least partially explained by an increase in per-worker burden associ-
ated with public policy.
The Clinton Administration would be well served to reverse the anti-small
business bias of the Bush years, returning to the environment of the Reagan
era, which provided a regulatory and tax setting conducive to the hiring of la-
bor.
The twin goals of high living standards and substantial job opportunities for
American workers are incompatible objectives unless the productivity of labor
150
rises. That is something nearly all of us, I think, agree on. High wages price
workers out of markets, so getting rising wages and more employment requires
output per worker to rise. President Clinton seems aware of this imperative.
Two likely planks in the Clinton economic program are infrastructure con-
struction and job training programs. Infrastructure investment should be made
based on its expected rate of return to society. Public works programs to aug-
ment employment simply do not seem to be effective, based on history.
Five years into the New Deal, for example, and eight years into the Great
Depression, massive public works expenditures had left the Nation with an
unemployment rate approaching 20 percent, with a modest improvement from
the depression trough being explained by productivity growth in the private-
sector. Federal spending crowds out private-sector spending, and there is
some evidence that a shift of resources to public uses causes a drag on labor
productivity.
That aside, public works projects take a long time to implement, at least a
year, and by the time infrastructure spending comes on line, the unemploy-
ment problem will be eliminated.
Finally, how can a nation be serious about deficit reduction if it is introduc-
ing new spending programs?
Regarding job training, the evidence with respect to federal job training
programs is not particularly reassuring. With respect to public education, there
are more than 100 scholarly studies showing no relationship between spending
and student achievement.
Without substantial changes in the delivery system for education, spending
in this area is likely to be counterproductive. More important, however, there
is decisive evidence that the most important variable in improving labor pro-
ductivity is work experience.
Male high school graduates, who are full-time workers working year- round,
average less than $16,600 a year in 1991 if they were 18 to 24 years old, but
more than 532,000 a year if they were 45 to 49 years old.
Assuming workers are roughly paid according to productivity, the more ex-
perienced workers seem to be roughly twice as productive as the relatively in-
experienced ones. The earnings gains for women tended to be somewhat less,
but are still substantial. Yet public policy has failed miserably in getting per-
sons to take that critical first job and stick with it. This is particularly true of
the disadvantaged and racial minorities.
In the year of BroAvn vs. Board of Education, at the very beginning of the
civil rights movement, 58 percent of nonwhite Americans of working age had
jobs. In 1992, the proportion was less, under 56 percent. By contrast, for
whites, the proportion working increased dramatically over time, from about
55 to 62 percent.
In 1954, nonwhites outworked whites, while today the reverse is true. This
is so despite a myriad of civil rights laws designed to reduce racial discrimina-
tion.
Why has this happened?
I would argue that federal programs designed to help low-income Americans
disproportionately affect minorities. These programs have reduced the work
ethic among the poor relative to the nonpoor.
151
The true marginal tax rate on work income for black Americans is probably,
on average, much higher than it is for whites simply because of the insidious
effects of public assistance programs.
A young black teenage girl with a baby, considering taking welfare or a $6
an hour job, will usually take welfare since the welfare benefit package is worth
as much as work income. There is effectively a 100-percent tax on work.
The white male graduating from college in engineering, however, will take a
$30,000 a year job over a $12,000 welfare alternative. Our public policies dis-
courage work efforts among the minorities, preventing them from taking the
first step up the job training ladder towards more productive employment.
Thus, public policy has robbed the Nation of productive resources; we have
prevented some of our citizens from taking low-paying jobs that lead to the
experience and productivity gains that ultimately result in more remunerative
employment. Median black family income has declined relative to white in-
come since 1967, despite narrowing pay differentials in comparable employ-
ment, simply because of declining labor force participation among blacks,
which I think results, in large part, from public policy.
In short, public policy has deterred productivity growth, has promoted un-
employment, and has been regressive in the most fundamental meaning of that
word. Instead of re-creating old programs that have failed in the past, I would
hope that the Clinton Administration look to new market-based solutions to
our problems of unemployment and inadequate productivity growth.
Thank you very much.
[The prepared statement of Mr. Vedder starts on p. 191 of Submissions for
the Record:]
Representative Obey. Thank you everyone.
Mr. Vedder, I am not sure where to begin. I think I am going to begin with
a quote from Mr. Weill's paper.
He said:
I believe that the American people feel that with the high production at
which we are now capable, there is enough left over to prevent extreme
hardship and maintain a minimum standard floor under subsistence, edu-
cation, medical care and housing to give all a minimum standard of de-
cent living and to all children a fair opportunity to get a start in life.
That statement was not uttered by George McGovern or Bill Clinton or any
other left-wing radical; it was said by Bob Taft, which explains why, when I was
a freshman in high school in 1952, I distributed literature to one-third of the
households in my hometown for Bob Taft. It was at that time, when I thought
I was a Republican — I always kid my Republican friends about this — that I
learned how to read, and changed parties. But I really did think that Bob Taft
was an intelligent conservative, who understood that the purpose of economic
policy was to effect human conditions. And I think, frankly, that Bob Taft's
intelligent and constructive conservatism has been taken over these days by a
strain of ideological conservatism which separates theory from human impact.
Frankly, I think a couple of points that you make in your statement, while
they are certainly interesting on a theoretical basis, they don't hold up when
you take a look at the real world.
For example, and I would ask Mr. Marshall and Mr. Weill to respond to
this, as well. You indicate your opposition to raising the minimum wage, that
the increase in the minimum wage in 1980 had a very negative effect on the
152
economy. I would say that if you take a look at the chart, which Mr. Shapiro
submitted in his testimony, it shows, relative to the poverty line — and if I am
misreading this, please correct me, Mr. Shapiro — that the minimum wage de-
clined in purchasing power relative to the poverty line by more than 30 percent
between 1978 and 1990; that the action taken by the Congress to raise the
minimum wage, after we endured, I believe, at least, one presidential veto, that
that bill simply reduced the gap between the poverty line and the effective
minimum wage by one third. It seems to me that hardly had a dramatic effect
on the economy.
I would also submit that I find it quaint that we have people from a wide
variety of sectors in the economy coming in defending the principle of indexa-
tion of income tax rates, promoting the idea of indexing depreciation, and yet
opposing the idea of indexing the minimum wage.
We have all kinds of people in this society whose wages are indexed in one
way, shape or form. Senior citizens under Social Security, and a lot of federal
employees' wages, except the very highest paid ones, are indexed. Why
shouldn't we, as a simple matter of equity, at least, index the minimum wage
that goes to the least advantaged people in this society?
Mr. Vedder. Well, you have made several points. The first one you made, I
must say, I was somewhat amused by it, because I went just the opposite way.
I voted for Lyndon Johnson in 1964, and as I read the evidence and so forth of
the 1960s and 1970s, I changed my political perspective in somewhat of a dif-
ferent form than you did, Congressman.
Representative Obey. One of us was very wrong.
Mr. Vedder. Well, my grandfather was chairman of your political party in
the state next door to you for 12 years. So I come from a background that has
always considered itself very compassionate and very interested in dealing with
the poor and with those people who are disadvantaged.
I think what we are really discussing are our differences in approaches of
dealing with those problems, rather than one of different motives.
With respect to the minimum wage, there is a variety of different evidence
relating to its effects on the economy. There are equity issues, but the equity
issues are sometimes more complex than perhaps your statement has made it, I
think.
For example, in the second quarter of 1990 — and this is from the Economic
indicator, which your Committee apparently put out — the average compensa-
tion per worker in the business sector of the economy rose 8 percent on an an-
nual basis. This is after years of wages moving up 3 or 4 percent a year.
That explosion in wages in that single quarter, I think, probably was at least
partially explained, if not totally explained, by the increase in the minimum
wage of 13 percent on the first day of that quarter.
Now, I think that that had something to do with pricing labor out of the
market, something to do with the increase in unemployment that occurred
over the next year.
Representative Obey. What empirical evidence do you have for that
hunch?
Mr. Vedder. I have just finished a book, Representative, which I have been
working on, on and off, for 1 8 years, in which I looked at the relationship be-
tween wages and employment and wages and unemployment. There is a very
153
striking, strong statistical correlation, which has actually shown in one of the
graphs in the full statement that I presented. When you see a pushup in
wages, such as we had in 1990, and also a secondary effect in 1991, when in
the second quarter of that year the average compensation increase was 5.6 per-
cent, which is again well above the long-run sustainable average; when I look at
the historical record on the relationship between wages and employment, and I
look at what are seeming effects of the 1990 and 1991 increases, certainly
there are aberrations in the data, in terms of increases in wages in the very
quarter in which these minimum-wage increases are going in. When I see that,
I say the two are related. And the tragedy to me is that the burden of that falls
on the people who are least capable of sustaining the damage. It falls on mi-
norities; it falls on low-skilled workers; it falls on teenagers.
Representative Obey. Mr. Vedder, I would simply say that that is an inter-
esting theory, but I don't think you have cited any empirical evidence to back it
up.
Mr. Vedder. Well, I would be glad to get you
Representative Obey. Since we are going to be spitting off our theories,
Mr. Shapiro, I know you wanted to comment, I will call on you in a minute.
But first, I want to express my view about how the 1990 recession began.
Mr. Vedder. Sure.
Representative Obey. In my view, what happened is that the economy was
being sustained for a long time, because people were spending a very large per-
centage of their income and saving very little, and in the short-term that was
sustaining consumer demand. And then I think we had a political act which
shook the confidence of consumers all over the country. I think we had the
decision by President Bush, after the Congress, rightfully, in October
1990 — in my view, this is one of the few times that Mr. Gingrich and I agree,
but we agreed for opposite reasons — turned down the budget summit agree-
ment.
This budget summit agreement called, among other things, for tax increases.
But the tax increases that it called for, for people between $20,000 and and
$50,000 incomes, were twice as large as the tax increases called for on the part
of people above $200,000. That is the reason that I helped organize the
Democratic opposition to that summit, and that was brought down.
At that point, the President had two choices. He could have chosen to sign
a continuing resolution and keep government going, and try to work out an-
other compromise not only with us, but with the right wing of his own party, or
he could have chosen to do what he did — which is to say, he is going to stop
government by vetoing the continuing resolution, shutting down the Washing-
ton monument, and telling the country that, in effect, the government was out
of control.
I deeply believe that that act, when he decided to do the latter, took the
confidence right out of the country. I think consumers took a look at that and
said, "My God, it is bad enough that families are being squeezed. It is bad
enough that we are in debt up to our ears. It is bad enough that the govern-
ment is in debt up to its ears, but now the political system is even out of con-
trol." And I think that really shook them. i'\nd I think that made it much easier
for their attention to be focused on the real problems in this economy. I think
that substantially weakened consumer demand, and people simply quit buying
154
because they were scared. And I think that is primarily what brought on that
recession.
Now, I don't have any more empirical evidence to back up my theory than
you have to back up yours, in my view.
Mr. Vedder. Well, I would argue that I have 338 pages of empirical evi-
dence in my book, which isn't specific to the 1990, 1991 recession, but it is
specific to a long-term historical pattern of behavior.
Representative Obey. Well, I will get to that historical pattern in a moment,
because I have two other questions I want to ask you.
Mr. Vedder. Sure.
Representative Obey. I just have to say that I think you have to do better
than to blame a tiny increase for the lowest paid workers in this society for the
collapse of consumer confidence and tossing the economy into the dumpster.
I frankly think your theory is farfetched.
Mr. Vedder. Well, you recall, that is your theory, not mine, about pushing
the economy's confidence down with regards to the minimum wage.
Representative Obey. I understand.
Mr. Vedder. I do think, by the way, that there is some substance to what
you said regarding confidence. I don't think confidence was very high in 1991,
either. Just so that I am not misquoted, I did not suggest that raising the mini-
mum wage led to a decline in confidence, and that that was the reason.
Representative Obey. I understand. But you did indicate that it had a sub-
stantial impact on causing the recession in 1990, and I respectfully disagree
with that.
Mr. Vedder. Sure.
Representative Obey. Mr. Shapiro, I know you wanted to comment on that
point. Why don't you proceed.
Mr. Shapiro. I actually think that Professor Vedder's comment is a classic
case of showing correlation without coming close to proving causality. You can
go back to other periods in economic history when the minimum wage was
much higher than it was in 1991, and was rising at a faster pace than it did
from 1990 to 1991 or 1989 to 1990. In the 1960s, there was a much higher
minimum wage rising at a faster rate, and that was one of the best economic
expansions in history. I am not saying the minimum wage was responsible for
that; neither was it responsible, as you point out so well, Mr. Chairman, for the
recent recession.
There were so many other large macroeconomic factors influencing what
was going on the economy that an increase in the wage of the lowest paid
workers, which only affected about 5 percent of the work force, certainly did
not tip off the recession.
Another thing I would like to mention is that the empirical evidence shows
just the opposite of Professor Vedder's point. There have been several studies
specifically of the increases in 1990 and 1991, and what the effect of those in-
creases were on job formation. For example, the studies would compare em-
ployment trends in a state that had relatively high wages to a state that had lots
of minimum wage workers, and they examined, "Well, if you have an increase
in the minimum wage, you would think that would hurt employment more in
the low-wage states, because more of those workers would be affected." But in
fact, when that state-by-state analysis was done by Professor Card of Princeton
155
University, it showed that there was no correlation between the amount of
minimum wage workers in the state and employment trends in the state.
Moreover, if you take a time series analysis that goes from 1954 all the way
up through 1986, and that attempts to isolate the relationship between the
minimum wage and employment trends, it shows that the employment effects
are very small.
Representative Obey. Let me turn to a different question.
Mr. Vedder, I don't mean to keep singling you out, but I was so startled by
two other things that you said that I do have to respond.
Mr. Vedder. Sure.
Representative Obey. In your prepared statement, you seem to suggest that
President Roosevelt's continued efforts to bottle a high-wage policy, trying to
bring the country out of the Great Depression, kept the markets from working
normally; implying somehow, I think, that the Depression would have been
less severe, or we would have worked out of it more easily, if there had been
no job program.
When you testified that he continued the high-wage policy through the pro-
grams you listed, is it your view that the policies of the 1980s, for instance,
were better and a better approach to creating jobs than Roosevelt's?
And, if you are, are you aware of the fact that private -sector employment,
following the trough of the 1981-82 recession, grew for one twelve-month pe-
riod by 6 percent, but for most of the rest of the recovery, it grew at an annual
rate of 2 to 3 percent? Whereas, in the period you cite under Roosevelt, it
grew at an annual rate of 15 percent, from 1933 through 1937. I guess I have
trouble following your logic, given those numbers.
Mr. Vedder. There was a very substantial difference between the 1930s and
the 1980s. I am surprised you use that example. Actually, this is one thing
that economic historians and theorists pretty much agree on.
One of your witnesses this morning, Professor Solow, has spoken specifi-
cally along the same Hne that I have with regards to the Roosevelt policy. Be-
tween June 1933 and December of that year, factory wages rose 12 percent in
six months. And the unemployment rate, which had been coming down for
several months following the bank holiday in March, shortly stopped falling
and stayed constant for two or three years. Then, only after the effects of the
National Industrial Recovery Act had been absorbed, and that law had been
proved unconstitutional, for a time there was a further reduction in unemploy-
ment. Similarly, the Wagner Act in 1937 led to an expansion of wages that
year of about 13 percent, and the recovery stopped in its tracks, and we had a
rise in unemployment to almost 20 percent in 1938.
Representative Obey. Can you tell me what the fiscal policy was during
that same period under Roosevelt? Because, as you know, there was signifi-
cant action taken by Roosevelt in contracting the economy after his initial ef-
forts to stimulate it.
Mr. Vedder. The Federal Government ran a deficit in most of the years in
the 1930s. There is an argument that state and local governments were run-
ning surpluses during much of that period, and there is some debate as to the
precise amount of the fiscal stimulus, or lack thereof, in the 1930s.
156
Representative Obey. But you don't deny that over that period, Roosevelt
substantially reduced the stimulative activities that he had been pushing earlier
in his terms?
Mr. Vedder. I certainly disagree with that, Congressman. I think the New
Deal was a great new adventure in government stimulus to the economy. The
Works Progress Administration
Representative Obey. You don't distinguish between different degrees of
stimulus in different stages of Roosevelt's presidency during that first term?
Mr. Vedder. The stimulus certainly varied from year to year, and there is an
argument in support of what you are saying, actually, in 1937 and 1938 there
was a reduction in fiscal stimulus.
Representative Obey. There sure was.
Mr. Vedder. But there was also this wage explosion that I was talking
about. There was also monetary changes going on.
To compare job growth from 1933 to 1937, when in March the unemploy-
ment rate, I estimate, was at over 21 percent, and compare that with 1981 to
1985, 1 think, is a little disingenuous, and I
Representative Obey. Well, then let's go to your statement about World
War 11. You indicated that, I believe, our post-WoHd War 11 adjustment was
handled quite nicely without the markets, without special efforts at job crea-
tion. I guess I have a difficult time following that.
What do you call the GI Bill, which was a huge government effort to up-
grade the skills of millions of workers returning from the war? What do you
call the housing programs, which had a substantial effect on construction at
that time?
If you take a look at the numbers, starting in June 1944, 7.8 million veterans
of World War 11 were enrolled at some time in education and training pro-
grams under the GI Bill. There were 2.3 million colleges, 3 to 3 and a half mil-
lion other schools, 1.4 million job trainees and 700,000 farm trainees. The
veterans' housing benefit raised housing starts by 60 percent between 1946 and
1948. Why on earth would those programs not be considered to be job crea-
tion and economic stimulus programs?
Mr. Vedder. By the way, I agree with you about the GI Bill. In fact, I wish
we had a GI Bill at the public education level today.
With respect to the overall picture, though, the Nation ran from a very sub-
stantial budget deficit — which, as I point out in my testimony, would be the
equivalent today of over a trillion dollars in calendar 1945 — to over a $200 bil-
lion budget surplus, putting it in the context of the present size of the econ-
omy, in 1946. Housing was not a big factor then, even public housing.
It took a while after the war for these programs to get geared up. The Fed-
eral Government let 10 million people go from employment. Most of them
went very voluntarily. They were soldiers who were being released. But 10
million people left federal employment. Every economist in the country virtu-
ally was predicting unemployment. Some of them were predicting 14 percent,
some 10, some 12, including some who went on to win the Nobel Prize, I
might add, and yet the unemployment rate never got above 3.9 percent.
Everyone said, well, it is because we had a lot of stimulus in the economy,
consumer spending, and it did grow. But it didn't really impact much on the
economy in that first critical year after the war. Even auto production wasn't
157
back to normal. And so we had, I think, a market adjustment that worked
fairly well. Harry Truman left office with a real public debt per capita that was
less than when he came in.
Representative Obey. But that is a very different question. You are putting
up a strong hand that I didn't build. I am happy that you remind people that
Truman was fiscally responsible. In fact, if you take a look at the record of all
Democratic presidents in this century compared to Republican presidents, you
will find that deficits have increased much faster under the Republican presi-
dents than they have under Democratic ones.
But I think that is beside the point. I was simply challenging your assertion
that it was market forces left to their own devices that solved the problem.
You know, there were just a few additional activities on the part of government
at that time, in addition to the GI Bill and the VA housing programs and all the
rest. You also had a little matter of price controls. They were used for a while
to mitigate market forces.
I guess my problem with your testimony — and this is the only point I make
before I turn to the other witnesses — I think most of the decisions have to be
made in this economy by the private sector. But the idea that government has
to leave to market forces almost the exclusive responsibility for dealing with
these problems is, I think, not very practical.
It just seems to me that the CEO of a corporation has a greater responsibil-
ity than the President of the United States. The CEO of a corporation is sup-
posed to maximize the return to the shareholders. The job of the President of
the United States is to maximize opportunity for everybody in this society, and
I think that demands that government take actions to mitigate the otherwise
Darwinist effects of the market. And I think that that is what the President is
going to be trying to do.
Let me ask, Mr. Weill, I want to play the devil's advocate with you for a mo-
ment. You cited the need to deal with Head Start, to deal with Job Corps.
You mentioned earned income tax credit — one of you did. I have forgotten
which one. You have listed a number of other items to assist children.
I want to say the same thing that I said to Mr. Marshall. My instincts tell me
that all of that is correct. But how do you answer the charges that some people
will make that these programs really are not that effective? What data would
you cite to demonstrate that the jobs that you are suggesting that we invest in,
in fact, will produce results, other than making us feel better because we
tossed some dollars at the problem?
Mr. Weill. Well, the effectiveness is manifested in a variety of ways — first
of all, in the improved conditions and resources of the children involved, and
second, in long-term economic and fiscal savings. Many of theseprograms cre-
ate long-term economic and fiscal savings for the country. The studies of
Head Start and comparable high quality early childhood development pro-
grams show returns of $3 or $4 and more for every dollar invested, in reduced
school failure and grade repetition, in reduced welfare costs, and other out-
comes.
The studies of childhood immunization show that for every dollar we have
spent on childhood immunization in recent decades, we have saved $10 in the
other costs. The Job Corps ratio is lower, but roughly a dollar and a half is re-
turned for every dollar spent. And throughout these programs — prenatal care,
158
early health care for infants and toddlers, the WIC program — all of these
things have been shown to have very high or relatively high rates of return.
So even if we weren't compelled to do these things morally and out of a
sense that our society depends on treating our children and treating each other
with some minimum decency, even if those benefits alone didn't drive this, we
would be compelled to do it by the returns on the investment.
One thing that we need to do is to look at the returns more broadly. For
example, it is our sense that childhood poverty itself is costing this country tens
and tens of billions of dollars a year down the road through school dropouts,
through teen pregnancy, through higher mental retardation costs, because poor
pregnant women and poor babies have higher disability rates, and through
other bad outcomes.
We have undertaken a project — Mr. Solow has agreed to assist in an advi-
sory capacity — to try and quantify the cost to this country of sustaining child
ptoverty rates that are two, three, five, ten times those of our economic com-
petitors. We think, in the end, the evidence will show that the country has to
eradicate childhood poverty for its own economic well-being.
Representative Obey. Just one other question. In your draft statement, you
said:
The growth in the number of young families, heads of families with chil-
dren, is in part a reflection of changing values, but the economic hard-
ships associated with fallen earnings and persistent joblessness among
young adults also has contributed significantly to failing marriage rates
and increasing rates of out-of-wedlock childbearing.
As you know, some would make just the reverse argument, that it was the
latter that caused the former. What would your response be to that argument?
Mr. Weill. Well, the evidence from Northeastern University and others is
that the wages of young men are a determinant, not the sole determinant, of
marriage rates among young adults. Actually, there is also a quote in the testi-
mony from Ben Franklin to that effect, so the phenomenon was noticed a cou-
ple of centuries ago — that young men whose incomes are above the poverty
level for a family of three or four are several times more Kkely to get married
than are young men whose wages are below the poverty line. There is substan-
tial evidence that, as young men's wages have gone down over the last two dec-
ades, and millions more young men have dropped below the family poverty
level in their wages, that has contributed to the decline in the marriage rate.
There is certainly an array of cultural and other factors that have contributed.
That points out something I wanted to say about Mr. Vedder's testimony.
Market forces, of course, don't exist in isolation. There is a culture going on
around it. There are a number of forces in effect at any time. After Worid
War II, one way the Nation dealt with the 10 million men who were returning
was to have several million women give up their jobs. That helped keep the
unemployment rate down. Whereas, in the last three decades, several million
additional women have entered the work force.
Mr. Vedder has addressed himself specifically — I am sorry he had to
leave — to jobs and not to the effects of lower wages. And our concern is about
the effects of lower wages not just on family economic security, but on the abil-
ity of families to stay together, families' attachment to the work force and to
the broader society. There is a ripple effect of these low-wage strategies that is
pulling the society apart. And if we continue to keep young workers' and
159
young children's family incomes down, it is eventually going to threaten the
future viability of this society.
Represe.\tati\t: Obey. I agree uith that ver>' much. One of the issues which
is getting a lot of discussion lately is the issue of generational equity. And I see
some people using their concern about that issue to argue that we ought to
make substantial scalebacks on benefits for seniors, for instance. Something
which I do not agree with.
But I have never understood why people don't understand, if you don't deal
uath this issue of earning capacity on the part of the young workers, that really
will create much worse generational inequity than, say, a small cost-of-living
increase for a senior citizen at the poverty level. And it just seems to me that if
we don't deal with this problem at the beginning of the pipeline, it is silly to
worr\' about it at the end of the pipeline, because by then you are too late and
you have missed the opportunity to really reduce that generational inequity.
Mr. Weill. I think that is absolutely right. We would certainly agree that
the answer to these problems is not to reduce benefits for the elderly. There
are too many elderly people living just above the poverty line and struggling.
So it is not a question of generational warfare. This country is wealthy enough
to adequately support both of its dependent populations through other mean-
s — the elderly and children — so we can live in a civilized society and protect
the future interests of this country.
What we would hope for from the elderly and older workers is the recogni-
tion that investing in children is essential to the viability of social security and
the future viability of the country.
REPRESENTATrvE Obey. Mr. Shapiro, did you have anything to add before we
shut it douTi?
Mr. Shapiro. No.
Representative Obey. All right. Well, thank you both for coming. I am
sorry Mr. Vedder had to leave to catch a plane, but I appreciate the time of all
of you today.
Tomorrow morning, we will continue with a panel who will be addressing
the question of what kinds of investments we can make on the capital side in
order to try and improve both the investment picture in the country and the
economic performance picture, as well.
Thank you very much.
[Whereupon, at 3:35 p.m., the Committee adjourned, subject to the call of
the Chair.]
160
SUBMISSIONS FOR THE RECORD
PREPARED STATEMENT OF RAY MARSHALL
"A High-Income, High-Producivity Economic Strategy"
Thank you, Mr. Chairman, for this opportunity to share with you and other mem-
bers of this committee some of my views on the economic outlook for 1993 and the
economic problems facing President Clinton. It is important to distinguish some of the
immediate problems the administration faces from the longer-term structural problems
facing the American economy. The long- and short-term problems are related, of
course, because America's anemic economic recovery and the lack of job growth are
due to structural shifts in the U.S. and global economies requiring very different kinds
of macro, micro, and international economic policies from those we have followed in
the past.
The essential structural problem we face is making the adjustment from the eco-
nomic system that made the United States the world's leading industrial power in the
early part of this century to a more competitive global economy where we have some
serious economic disadvantages. Our early economic advantages were due to an abun-
dance of natural resources, a large and growing internal market which made it possible
to increase productivity very rapidly through economies of scale and favorable interin-
dustry shifts (like the movement of labor from low-productivity agriculture to higher
productivity manufacturing) and supportive economic policies. Especially important
economic policies were our mass education system which created what was at one time
the world's best educated work force; the land grant colleges and agricultural extension
system, which greatly improved the productivity of American agriculture; and the poli-
cies of the federal government, beginning in the 1930s, to sustain the production sys-
tem by generating aggregate demand through monetary- fiscal policy, collective
bargaining, social security, worker protections and unemployment compensarion.
These policies helped usher in the longest period of relatively equitably shared prosper-
ity in our history from the 1930s to the early 1970s.
As you know very well, Mr. Chairman, technological changes and the globalization
of markets have eroded the advantages Americans formerly enjoyed. Technological
change is essentially the substitution of ideas, skills and knowledge for physical re-
sources. In a knowledge-intensive world, natural resources become less important and
human resources become critical to economic success.
Similarly, globalization changes the requirements for economic success and makes
it much more difficult to regulate economic activity through traditional economic poli-
cies. We now have to be more concerned about the effect of our policies on exports,
imports, and exchange rates which can accelerate or nullify the effects of national
monetary and fiscal policies.
Some of the most important combined effects of international competition are on
the economic competitiveness of businesses. In this new environment, companies,
countries, or individuals confront a clear choice: they can either attempt to compete by
costs, mainly wages, or they can take measures to improve productivity and quality.
Most democratic industrialized economies have rejected the low-wage option because
it implies lower and more unequal wages and limits improvements in incomes to work-
ing harder. The other option, to improve productivity and quality, requires that we
compete by substituting ideas, skills and knowledge for physical resources. We do not
know the limits to this option but it clearly implies much steeper learning and earning
curves than the low-wage strategy. However, the high-productivity, high-income option
requires a concerted economic strategy-it won't just happen. The passive policies we
have followed in the United States since the 1970s will automatically lead to a low-
wage competitiveness policy. The high productivity strategy therefore requires active
policies to discourage low-wage competition and encourage companies to compete by
improving productivity and quality. Low-wage competition is discouraged in most
161
European countries through high social safety nets; active labor market policies; well-
trained and well-educated work forces; the empowerment of workers in the work place
and in the polity and society; and greater policy stability through consensus-building
processes. The absence of these policies and processes in the United States has per-
mitted us to back into low-wage competition. As a consequence, productivity growth in
the United States has been stagnant, real wages for most workers are lower now than
they were in 1970, and American wages are more unequal than at any time in the post-
war period.
I do not have time to oudine all that is required to restore the United States to the
high-productivity track. We know, however, that we must provide incentives for com-
panies to become high-performance organizations. High-performance organizations
stress quality, productivity, and flexibility through work organizations that provide a
high degree of worker participation in work place decisions; the development and use
of leading-edge technology; continuing education and training of all workers, not just
managers; positive incentive structures instead of the negative or perverse incentives
found in many American work places; and an independent source of power for work-
ers.
My list of the things that we should do immediately include:
1 . Develop consensus to be a high-productivity, high-income country.
2. De\'elop an investment-led growth program that would stimulate the economy immediately through
measures that would strengthen our long-run prxxluctive potential, including:
a. A temporary minimum $60 billion annual fiscal stimulus, consisting of $50 billion in gnmts to
state and local governments and a $10 billion new investment tax credit for new investment.
b. A longer-term permanent program for targeted investment, mainly through state and local gov-
ernments, for education, training, inirastructure (especially 21st century information and trans-
portation infrastructure).
c. A credible pre-committed plan to reduce the budget deficit absolutely and as a percentage of
GDP as economic growth picks up.
d. A business-labor-govemment commission to build consensus on long-term strategies to promote
high levels of growth in productivit)' and output without inflation.
e. An agreement with the Federal Reserve to coordinate economic policy to reduce real interest
rates to support long-term growth policies.
It also would be useful for President Clinton to take the lead to modernize interna-
tional economic institutions and policies to support high-income, high-productivity eco-
nomic strategies in all countries and to provide adequate global economic growth.
Such policies require transparent, fair, and enforceable rules for international transi-
tions that would include services, intellectual property rights, and labor and environ-
mental protections.
I was one of the economists supporting the proposal formulated by James Tobin
and Robert Solow for a $50 billion a year investment program to strengthen the Ameri-
can economy. Fifty billion dollars represents about 1 percent of GDP. This proposal
was made last March, but I have seen nothing to justify changing the value of this pro-
posal. The first phase of the investment program could be in the form of temporary
emergency grants to states for programs based on clear need and capacity to spend on
sensible projects. This program, along with the temporary $10 billion investment tax
cut, should continue at least through fiscal 1994. Thereafter, a $50 billion a year tar-
geted investment program should continue for the rest of this decade. At least $25 bil-
lion is needed to maintain the nation's infrastructure and another %23 billion to close
the gap between the United States and other major industrial countries.
There are a number of options for paying for this program. I favor an immediate 8
percent energy tax which would yield approximately $30 billion a year. However, I be-
lieve we should consider shifting to a progressive value-added tax in the longer term
and reducing our dependence on corporate and personal income taxes. I would give
careful consideration to the infrastructure investment bank proposal by Felix Rohatyn
162
and Carol O'Cleireacain. This proposal would issue bonds to be repaid by dedicated
taxes.
Additional resources could come from a $150 billion cut in defense spending, as
proposed by Senator James Sasser, Chairman of the Senate Budget Committee, and
other deficit reduction measures. I also would restore some progressiveness in the in-
come tax by a 36 percent marginal tax rate on incomes over $200,000 a year, to be
used to reduce the income taxes of middle class tax payers. Other tax changes could
be levied to bring in another $30 billion a year, including a Medicare payroll tax, taxing
capital gains at death, and limiting mortgage interest payments.
Simulations by the Economic Policy Institute, on whose board I serve, show an in-
vestment program of $50 billion over an eight-year period would do more than either
an austerity program or a more modest "muddling through" strategy to strengthen the
economy and reduce the long-run budget deficit as a percentage of GDP; the invest-
ment strategy produces a budget deficit of 1.8 percent of GDP by 2000, compared with
3.8 percent for muddling through and 2.4 percent for austerity. Importantly, the in-
vestment strategy produces $1 trillion more investment over the 8-year period (see Ta-
ble 1).
A major deterrent to the investment-led strategy is the fear of inflation and continu-
ing growth in budget deficits. I do not believe we face a serious inflationary threat in
the immediate future, but these problems should be dealt with in a credible fashion
before they become serious threats. A credible deficit reduction program over the
longer term could be developed by enacting deficit-reducing measures immediately that
would become effective in two to three years after the investment-induced growth takes
effect. It would, however, be a serious mistake to reduce the budget deficit before eco-
nomic grouth picks up. There is no evidence that budget deficits are currently crowd-
ing out private investment.
A Human Resource Development Strategy
Mr. Chairman, I believe it is particularly urgent for the United States to adopt a
comprehensive human resource development strategy to improve the education, skills,
and health of our people. A group associated with the National Center on Education
and the Economy, of which I am a trustee, has proposed such a strategy to the Clinton
administration (NCEE, A Human Resource Development Plan for the United States,
1993), and Marc Tucker and I elaborate the need for such a strategy in our book,
Thinking for a Living (Basic Books, 1992).
The legislative agenda we propose includes measures to improve our schools
through a system of national performance standards benchmarked to the highest in the
world. A national education system should be established linking curricula, pedagogy,
examinations and teacher education to the national standards. This system would per-
mit substantial variation among the states and local school districts, but would abandon
the American tracking system and make schools responsible for ensuring that all stu-
dents meet the high standards required for graduation. Student who meet the high
standards for graduation should be rewarded by further education and rewarding ca-
reers.
Schools would be reorganized to reduce administrative personnel and rules and
regulations that have little to do with student achievement. School professionals would
be freed to make the key decisions to bring students up to the standards, and school
professionals should receive adequate compensation and support needed to do their
jobs.
Postsecondary Education And Work Skills
All students who meet high standards for general education should be entitled to
three years of additional free education. Loans, which could be forgiven for public
service, should be available for additional education.
National standards, established with the participation of employers, labor, and aca-
demics, should be established for sub-baccalaureate college-level technical certificates.
163
These programs should include academic and structural on-the-job training and should
be linked to baccalaureate and higher degrees.
There also should be a system of on-the-job training and education for all workers
paid for through a requirement that employers spend an amount equal to 1.5 percent
of payroll on training for all workers leading to a national skill certification.
Labor Market Systems
One of the most important problems for employment and training in the United
States is the absence of a coherent labor market system. We therefore should establish
a system of labor market boards at the local, state, and federal levels to coordinate job
training, postsecondary technical education, adult basic education, job matching, and
counseling. The Employment Service should be upgraded, separated from the Unem-
ployment Insurance Fund, and supervised by these boards. This system should provide
readily accessible counselors to any person to help assess needs, plan and finance a
training and education program, and locate available jobs. Clients of the labor market
boards should be able to have all of their needs addressed at a local labor office.
Mr. Chairman, this summarizes our recommendations. I believe these recommen-
dations would go a long way toward developing a high -productivity, high-income strat-
egy for the United States. The Clinton administration and the Congress face serious
economic problems, but they also have a golden opportunity to make a dramatic shift
in our economic policies. The alternative is to continue to experience growing inequal-
ity of opportunity and economic stagnation. It seems to me that the path we should
take is very clear.
Thank you. I would be glad to answer questions you or other members of the com-
mittee might have.
Tjble I
Long-Term Investment Strategy Effect
(EPl Baseline, Fiscal Years)
FWSTTERM
SECOND TERM
1992
1993
1994
1995
19%
1997
1998
1999
2000
RetlGDP
Auswnty
4975
5059
5139
5224
5308
5393
5479
5566
Muddle-Through
4875
4975
5075
5183
5288
5386
5478
5571
5664
InvestiTient
5000
5158
5256
5341
5480
5628
5785
5953
GDP
Austcnty
6139
6412
6696
7006
7328
7665
8018
8387
Muddle-Through
5&M
6139
6435
6763
7116
7460
7808
8169
8542
Investment
6173
6553
6888
7208
7613
8047
8514
9017
Unemployment Rate
Austerity
7.1
6.6
65
6.4
6.7
7.0
73
7.6
Muddle-Through
73
7.1
65
62
5.9
6.0
6.1
62
63
Investment
67
57
5.6
5.8
5S
5.8
5.8
5.8
Investment
Austerity
361
373
382
394
408
422
437
452
Muddle-Through
345
361
375
391
406
422
433
450
465
588
Investment
363
391
413
432
467
504
544
Deficit OMTPA basis)
Austen ty
284
236
231
229
201
151
173
198
As a % of GDP
4.6
37
3.4
33
27
2J)
12
2.4
Muddle-Through
287
284
274
295
313
327
327
328
325
Asa % of GDP
4.9
4.6
4J
4.4
4.4
44
*2
4.0
3.8
Investment
298
280
301
275
249
219
189
159
1.8
As • * of GDP
4.8
43
4.4
3.8
33
27
27
Deficit (Unified Budget basis)
Austen ty
357
278
253
232
207
ISO
172
200
As a * of GDP
5.8
43
3S
33
2.8
2.0
2.1
2.4
Muddle-Through
316
357
316
317
316
333
326
327
327
3.8
As a % of GDP
5.4
5.8
4.9
47
4.4
45
47
4.0
Investment
371
322
323
278
255
218
188
161
As a % of GDP
6.0
49
47
3.9
33
27
27
\£
Note: Muddle-Through and Investment scenanos assume healthcare refomi savings beginning m FY97;
the Austenty scenano assumes such savings beginning in FY94.
Source:
Economic Policy Institute. Letter from Jeff Faux to President-elect Clinton.
November 18. 1992.
164
ATTACHMENT TO MR. MARSHALL'S PREPARED STATEMENT
A Human Resources
Development Plan
jhr the United States
NATIONAL CENTER ON EDUCATION AND THE ECONOMY
165
Prefii
"^ace
TTie advent ot the Clinton admirustration creates a unique opportunity for the countrv to develop a tiuiv nadonal svstem tor the
development of its human resources, second to none on the globe. The Nauonal Center on Education and the Economy and its
predecessor organizaaon. the Carnegie Forum on Educauon and the Economy, have been elaboraang a national agenda in this aiena
over the last eight v-ears. Here, we outline a set ot recommendanons to the incoming Clinton administration in the area of human
resources development. It builds direcdy on the proposals that the President-elea advanced during the campaign. This report is mamlv
the work ot a small group ot people with close ues to the Nauonal Center: Tim Bamicle. David Barram. .Vlichael Cohen. David
Haselkom. David Hombcck. Shiriev Malcom. Ray Marshall, Susan .VlcGuire. Hilarv Pennington, .-Kndv Platmer. Lauren Rcsnick,
David Rockefeller. Jr., Betsy Brown Ruizi. Robert Schwanz, John Scullcy, Marshall Smith. Bill Spnngand mv-selE ^"hile all of these
people are in general agreement with what toUows, they may not agree on the details.
— Sian Titckrr
166
Introduction
The ercat opporrunin' in tront of the councn.' now is co remold che encirc.\mencan svsrem tor human resources deveiopmenr. almost
all of the current components of which were put in place betore World War II. The natural course is to take each of the ideas that were
advanced in the campaign in the area ot educadon and training and translate them individuallv into legislative proposals. But that will
lead to these programs being grafted onto the present system, not to a new s\3tem. and the opportunity will have been lost. If this sense
of tmie and place is correct, it is essenoal that the nauons efforts be guided by a consistent vision of what it wants to accomplish in the
field of human resources development, a vision that can shape the actions not only of the new administration but of many others over
the next few v-ears.
What follows comes in two pieces:
First, a tnswnolxhe kind of nadonal — not federal — human resources development sv'stem the nation could have. This is interwoven
with a new approach to governing that should inform that NTsion. 'Oi'hat is essenual is that we create a seamless web of opportuniues to
develop ones skills that literally extends from cradle to grave and is the same sv'Stem for e\-er\-one — young and old. poor and nch.
worker and full-time student. It needs to be a s>'stem tJni'm by client needi (not agency regulations or the needs ot the organiiaaons
providing the services), gui/ied hv clear staru^rds that define the stages ot the s\'Stem for the people who progress through it. and regulated
on the basil of outcomes that providers produce for their clients, not inputs into the s\'stem.
Second a proposed legislative agenda the new administranon and the Congress can use to implement this vision. We propose four high
priority packages that will enable the federal govemment lo move quickly:
1 . T\\e first would use the President-elea's proposal for an apprentueshtp system as the kevstone of a strategy for putung a whole
new postsecondarv training system in place. That system would incorporate his proposal tor reforming postsecoruiary education
finance. It contains what we think is a powerful idea tor rolling out and scaling up the whole new human resources system
naaonwide over the next four years, using the (renamed) apprenticeship idea as the entenng wedge.
2. The second would combine initiatives on dislcKated workers, a rebuilt employment service and a new system of labor market
boards in a single employment secunty ptQ^im. built on the best pracuces anywhere in the world. This is the backbone of a
s>-5tem for assuring adult workers in our society that they need never again watch with dismay as their jobs disappear and their
chances ot ever getnng a good job again go with them.
3. The third would concentiate on the overwhelming problems of our inner anes, combinmg elements of the first and second
packages into a special program to gready raise the work-related skills of the people trapped in the core of our great cines.
4. The^rrA would enable the new administrauon to take adv'antage of legisbnon on which Congress has already been working
to advance the elementary and secondary refi)rm agenda.
167
The Vision
An Economic Strategy Based on Skill Development
♦ The economy's strength is derived from a whole population as skilled as any in the world, working in workplaces
organized co take maximum advantage of the skills those people have to offer.
•> A seamless s)'stem of unending skill development that begins in the home with the very young and continues through
schtxsl. poscsecondary education and the workplace.
The Schools
"> Clear national standards of performance in general education (the knowledge and skills that everyone is expected to
hold in common) are set to the level of the best achieving nations in the world for students of 16 and public schools
are expected to bring all but the most severely handicapped up to that standard. Students get a certificate when they
meet this standard, allowing them to go on to the next stage of their education. Though the standards are set to
international benchmarks, they are distinaly American, reflecting our needs and values.
♦ We have a national system ot education in which curriculum, pedagogy, examinations and teacher education and
licensure systems are all linked to the national standartis. but which provides for substantial variation among states,
distncts and schools on these matters. This new system of linked standards, curriculum and pedagogy will abandon
the American tracking system, combining high academic standards with the ability to apply what one knows to real
world problems and qtialifving all students for a lifetime ol learning in the postsecondary system and at work.
■> We have a system that rrwards students who meet the national standards with further educaaon and good jobs, providing them
a strong UKenavr to work hard in school.
♦ Our public school systems are reorganized to free up schcx>l professionals to make the key decisions about how to use all the
available resources to bnng students up to the standards. Most of the federal, state, distna and uruon rules and rcguladons that
now restna school profissionals' ability to make these decisions are swept away, though strong measures are in place to make sure
tfiat vulnerable populations get the help they need- School professionals are paid at a level comparable to tfiat of other
profissionals, but they are expeaed to put in a hill year, to spend whatever time it takes to do the job and to be fiiily accountable
for the results of their wortc The federal, state and local governments provide the time, staff development resources, technolo^
and other support needed for them to do the |ob. Nothing less than a wholly restructured sch(x>l system can possibly bring all of
our students up to a standard only a few have been expeaed to meet up to now.
•> There IS an aggressive program ofpublic choke in oiir schools.
♦ All students are guaranteed that thev will have a fair shot at reaching the standards, that is, tfiat wfiether they make it or not
depends only on the effort they arc willing to make. A determined effort on the part ot the federal government will be required
on this point. School delivery standaitls may be required. If so, these standards should have the same status in the system as the
new student pettbrmance standards, but they should be feshioned so as not to consntute a new bureaucraac nightmare.
Postsecondary Education and Work Skills
"> All students who meet the new nadonal standards for general educanon are endtled to the equivalent tjf three more years of &ee
additional education. We would have the federal and state governments match Kinds to guarantee one free year of college
education to everyone who meets ttie new nanonal standards for general education (the amount of this award woukl be set at a
stipulated maximum so as to avoid rtinawav charges for college tuition). So a student who meets the starxlaid ar 1 6 wtxild be
entided to two free years of high school and one of college. Loans, which can be forgKen for public service, are available for
additional education beyond that. National standartis for sui>-baccalauieace college-level profiasional and technical degrees and
certificates will be escablisfied with the patddpaaon of empkjyets. labor and fiighcr education. These programs will include both
academic studv and structured on-the-iob training. Eighty percent or more of Amencan high school graduates will be expected
to get some form of college degree, though most of them less than a barra laureate. These new professional and technical
certificates and degrees typically are won within tfiree years of acquiring the general educadon certificate, so, for most
postsecondary students, college will be free. These professional and technical degree programs will be designed to link to
prt)grams leading to the baccalaureate degree and higher degrees. There will be no dead ends in this sysrem. Everyone who
meets the general educadon standard will be able to go to some form of college, being able to borrow all the money they need to
do so. beyond the first free year.
This uUa ofpost-iecoruiaryprojissumdandtechmadcrrt^uaxes captures iJl of the esenaals of dx apfmrmcahip uiea, wtiile oSering
none of its drawbacks (see bdow). Biu it also makes it dear that those engaged in apprentice-style programs are getting more
than narrow training; they are continuing their educanon for other purposes as well, and building a base for more education latCL
Clearly, tins idea tedeflnes college. Proprietary schools, employers, and community-based organizations will want to offer these
programs, as well as community colleges and four-year instituaons. but these new entrants will have to be accredited if they are to
qualify to offo die programs.
•^ Employers are not required to prtjvide slots for the structured on-the-job training component of the program but many do so.
because diey get first access to tfie most accomplished graduates of these programs and diey can use diese programs to introduce
the trainees to their osvn values and way of doing tilings.
♦ The system of skill standards for tedinical and professional degrees is tiie same for students just coming out of high scirool and
for adults in die wotkforce. It is progiessive. in tiie sense dut cerdficates and degrees ft>r die entry level jobs lead to further
pttjfessional aixi tedwiical education programs at higher levels. Just as in tiie case of ti>e sysrem for tiie sciwols. drough die
168
standards are the same everywheie (leading to maximum mobility for students), the auricula can vary widely and programs can
be custom designed to fit the needs of hill-time and pan-time students with very different requuements. Government grant and
loan programs are available on the same terms to hill-ame and part-time students, as long as the programs in which they are
enrolled are designed to lead to certificates and degrees defined by die system ot professional and technical standards.
♦ The national system of professional and techrucal standards is designed much like the mulostate bar. which provides a nadonal
cone around which the states can specify addidonal standards tfiat meet their uruque needs. There are nauonal standards and
exams for no more than 20 broad occupanonal areas, each ot which can lead to many occuparions in a number of related
industnes. Students who qualify in any one of these areas have the broad skills required by a whole family of occupations, and
most are sufficiently skilled to enter the workforce immediately, with fijrther occupation-specific skills provided by their union or
employee Industry and occupauonal groups can voluntarily create standards building on these broad standards for their own
needs, as can the states. Saidents entering the system are first introduced to very broad occupational groups, narrowing over time
to concentrate on acquiring the skills needed for a cluster of occupauons. This modular system provides for the initiative of
particular states and industries while at the same time providing for mobility across states and occupauons by reducing the time
and cost entailed in moving from one occupation to another. In this way, a balance is established between die kinds of generic
skills needed to ftinction effectively in high performance work or^nizations and the skills needed to continue learning quickly
and well through a lifetime of work, on the one hand, and the specific skills needed to perform at a high level in a particular
occupation on the other.
*2* Institudoiu receiving grant and loan funds under this system are required to provide inferrrution to the public and to
government agencies in a uniform format This information covers enrollment by program, costs and success rates tor students
of different backgrounds and characteristics, and carrer outcomes for tfiose students, tfiereby enaf>lir^ students to make informed
choices among Insatuaons based on ctMt and performance. Loan de&ulcs are reduced to a level ckae to zero, both because
programs ttut do not deliver what they promise arc not sdeaed by prospective students and because the new poscsecondary loan
system uses the 1R5 to collect what is owed fiom salaries and wages as they are earned.
Education and Trammgjor Employed and Unemployed Adults
^ The rutionai system of skills standards establishes the basis for the development of a coherent, unified training system. That
system can be accessed by students coming out of high school, employed adults who want ro improve their prospects,
unemployed adulo who are diskxated and others who lack the basic skills required to get out of povert)'. But It is all the same
system. Thete are no longtr any parts ot it that are exdusrvely for the disadvantaged, though special measures are taken to make
sure that the disadvantaged are served. It is a system for everyone, just as ail the parts of the system already described are for
everyone. So the people who take advantage of this system arc not marked by it as damaged goods. The skills they acquire are
world class, clear and defined in part by the employers who will make decisions about hiring and advancement.
♦ The new general education standard becomes the target for all basic education programs, both for school dropouts and adults.
Achieving that standard is the prerequisite for enrollment in all professional and technical degree programs. A wide range ot
agenaes and institutions offer programs leading to the general education certificate, including high schools, dropout recovery
centers, adult educanon centers, community colleges, prisons and employers. These programs are tailored to the needs of the
people who enroll in them. All the programs receiving government grant or loan funds that come with dropouts and adults for
enrollment in programs preparing students to meet the general education standard must release the same kind ot data required of
the postsecondary insatutions on enrollment, program description, cost and success rates. Reports are produced tor each
insrimrion and for the system as a whole showing different success rates for each major demographic group.
♦ The system is funded in tour different ways, all providing access to the same ot a similar set of services. Schcx)! dropouts below
the age of 21 are entided to the same amount of funding ftom the same sources that they would have been entlded to had they
stayed in school. Dislocated workers are fiinded by the federal government through the federal programs for that purpose and by
stare unemployment insurance fiinds. The chronically unemployed are fimded by federal and state hinds established for that
purpose. Empbyed people can access the system through the requirement ttut their employers spend an amount equal to 1 and
1/2 percent ot their salary and wage bill on training leading to naoonal skill cenificaoon. People in prison could get reducuons
in their sentences by meeting the general education standard in a prtjgiam provided by the pnson sysrem. Any of diese groups
can also use the balances in their grant entidement or their access ro the student loan fund.
Labor Market Systems
♦ The Employment Service is gready upgraded, and separated from the Unemployment Insurance Fund. All available front-line
jobs — whether public or private — must be listed in it by bw [this provision must be carefully designed to make sure that
emplovers will not be subject to employment suits based on the data produced by this system — if they are subjea to such suits,
they will not participate] . .Ml trainees in the system looking for wori< are ennded to be listed in it without a fee. So it is no longer
a svstem |ust foi die poor and unskilled, but for everyone. The sysrem is hilly computenied. It lists not only job opening and
|ob seekers (with their quali£caDons) but also all the instimtions in the labor nurket area offering programs leading to the general
educanon certificate and those offering programs leading to the profissional and techmcal college degrees and certificates, along
with all the relevant data about the costs, characteristia and performance of those programs — for everyone and for special
populations. Counselors are available to any citizen to help them assess their needs, plan a program and finance it, and, once
they are trained, to locate available jobs.
•> A svstem of labot market boards is established at the local, state and lisleral levels to coordinate the systems fot job training,
postsecondary professional and technical educanon. adult basic education, job matching and counseling. The rebuilt
Employment Service is supervised by these boards. The system's clients no longer have to go from agency to agency filling out
separare applications for separate programs. It is all taken care of at the local labor market board office by one counselor accessing
the integrated computer-based program, which makes it possible for the counseter ro determme eligibility for all relevant
programs at once, plan a program with dK client and assemble the necessary funding from all the available sources. The same
svstem will enable counsefor and client to array all die relevant program providers side bv side, assess tfieir relative costs and
pertormance records and deteniune whkJi providers are best able ro meet the client s needs based on performance.
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Some Common Features
•> Throughout, the objen is do have a performance- and dient-orienced system and to encourage local creativity and responsibiLty
bv gemng locai people to commit to high goals and organize to achieve them, sweeping away as much ot the rules, regulations
and buieauctao' that are in their way as possible, provided that they are making real progress against their goals. For this to work,
the standards at every level of the system have to be dear, every client has to know what they have to accomplish in order to get
what they want out ot the system. The service providers have to be supponed in the task ot getting their clients to the finish line
and rewarded when they are making real progress toward that goal We would sweep away means-tested programs, because they
stigmatize their teapients and alienate the public replacing them with prtigrams that are for everyone, but also work for the
disadvantaged We would replace rules defining inputs with rules defining outcomes and the rewards for achieving them. This
means, among other things, permitting local people to combine many federal programs as they see fit. provided that the
intended benefioanes are progressing toward the right outcomes. We would make individuals, their families and whole
commuiuties the unit of service, not agendes, programs and proiects. Wherever possible, we would have service providers
compete with one aixxher for hirxls that come with the dient, in an environment in which die client has gtxxl information
about the cost and peifermaiKe record ofthe competing providers. Dealing with public agendes — whether they are schools tx
the empkmnent servKc — shoukl be wan like dealing with Federal Express than with the oM I^»t Ofiice.
An Agenda for the Federal Government
Government at every level has an enormous potential for aiJecring a nadon's human capadty — fiom. the resources it provides to
nourish pregnant women to the Incenaves it provides to employers to invest in the skill development of their employees. In this sccnon
we concentrate on the role die federal government can play and largely restna our field of vision to elementary and secondary
education, job training and labor market policy.
Everything that feUows is cast in the &arae of strategies for bringing the new system described in the preceding section into being, not as
a pilot program, not as a few demonstradons to be swept aside in another administradon, but everywhere, as the new way of doing
business.
The preceding section presented a vision of the system we have in mind chronologically from the point of view of an individual served
by iL Here we reverse the order, starting with a descnpdon of program components designed to serve adults, and working our way
down to the very young.
Hi^ SkUlsJbr Economic Conqietitweness Program
Developing System Standards
•^ Create a Nadonal Board for Professional and Technical Standards. The Board is a pnvate not-for-profit chartered by Congress,
Its charter specifies broad membeiship composed of leading figures ftom higher education, business, bbor. government and
advfxacy groups. The Board can receive appropnated Kinds fiom Congress, pnvate foundations, individuals and corporanons.
^4ellher Congress nor the execuove branch can dicate the standards set by die Board. But die Board is required to report
annually to the Ptesident and the Congress in order to provide for public accountability. It is also directed to work coUaboranvdy
with the states and dties involved in the Collaboraove Design atxl Development Program (see below) in die devefopment of die
standards.
"> Charter specifies that the National Board will set brmd performance standards {not time-in-ihe-seat standards or course
standards) for postsecondary Professional and Techrucal certificates and degrees at the sub-baccabureate level, in not more than
20 areas and develops performance examinaaons for each. The Board is required to set broad standartls of the kiixl described in
the vision statement above, and is not permitted to simply reify the narrow standards that characterize many occupations now
(more than 2,(X)0 standards currently exist, many for licensed occupations — these are not the kinds of standards we have in
mind). It also specifies that the programs leading to these certificates and degrees will combine time in the classroom with time
at the work-sire in structured on-the-job training. The Board is responsible for administenng the exam sysrem and continually
updating the standards and exams. The standards assume the existence ol prercquisire world class general educadon standards set
by the Narional Board for Student Achievement Standaitis, descnbed below. The new standards and exams are meant to be
supplemented for particular occupations by the states and by individual industnes and occupanonal groups, with support from
the National Board.
•;• Legislation creating the Board is sent to the Congress in the fint six mondis of the administration, imposing a deadline for
creating the standards and the exams within three years of passage of the legisboon.
Commentary:
Tht propoiol rrframa the Clinton apprmtkehip pmposal as a coUegr proprnn and alahlishe a mechanism fiiriemng the staruLmis for
the prvgmm. The umons are very concerned that the new apprmaccshtpi uiU be confuied with the established registered apprenticeships.
Focus groups conducted byjohtjir the Future and others show that patents eirr/wl'ert want their kids tog) to coUegr. not to be shunted
aside into a non-coilege apprenticeship "vocationai" program. By retjuinng these programs to be a combination of classroom instruction
and structured OJT. and creating a standard-ietting board that includes rmployen and labor, all the objectiie^ of the apprenticeship idea
are achieved while ai the same assurtrtg much broader support fhr the tdetL as urll as a guarantee that the pro-am u/iU not become too
narrowly focussed on paracular occupatwns. It also ties the Clinton apprennceship idea to the Clinton coUeg funding proposal in a
seamless web Charging the Board unth crraang not more than 20 cemfcatr or degree categpnes establishes a balance between the need
170
a ataa one mnonal rtsam m ;he ov hani with the need m moid crtatmg a cumhenimu and rip^ naiwnal burmucmey on :he other.
This approach provide! ion ofkutude^ mdanduai industry grottpi, pm^sstorud groups and state authontus to establish their own
suridardi. while as the sarriectrriexLmdmf the chaos that wouU surety muk^ they were the oriiysoum The inU establish-
inr the Board should also authome the ixtcutsix braruh to make grants to industry groups, professumai societies, occupational ^o:^ and
slates to develop their own standards and exams. Our assumption is that the system we art proposing will be managed so as to encoumge
the states to combine the last two years of high school and the first two years ofconmumty college into thre-year progmms leading to
coUm degrees and certificates. Propnetary institutions, employers and communiiy-hased oiganaatums could also offer these programs,
but they would have to be acaedited to offer these college-level pmpams. Eventually, students gemng then- grneml education cert^icates
might g3 dirmh to community college or to another firrm of college, but the new system should not require that
Coliabocaihv Design and Development Program
The objea is to create a single comprehensive system for protessional and technical education that meets the requirements of everyone
fiom high school students to skilled dislocatBd workers, from the hard core unemployed to employed adults who want to Improve their
prospects. Creacmg such a svstem means sweeping aside coundess programs, building new ones, combining funding authorities,
rhanging deeply ernbedded insarunonal structures, and so on. The question is how to get from where we are ro where we want to be.
Trving CO ram it down oervone's throat would engender ovncrwhelming opposioon. Our idea is to draft legislanon that would offe an
opporrunicy for those states — and selected large cities — diat are cxated about this set of ideas to come forward and join with each
odier and widi the federal government in an alliance to do the necessary design work and actually deliver the needed services on a last
track. The legislanon would requite the executive branch to establish a compeative grant program for these states and aties and to
engage a group of otgantzanons to offe tedinical assistance to die expanding set of states and acres engaged in designing and
imptemenong d>e new sywem. This is not the usual large scale expenment nor is it a demonstraaon program, bur a highly regarded
precedent exiso for dus appttwJi in die National Science FourxJanons SSI program. As soon as die first set of states is engaged, anodier
set wDuki be invited to pamapate. undl most or all of die states are involved. It is a coUaboracive design, rollout and scale-up program.
It IS intended to parallel die work of die National Board for Prohssional and TechnKal Standards, so dial die states and aties i and all
(and all dieir partners) wouW be able ro impiemenr die new standards as soon dwv become available, aldiough diey wouki be delivenng
servKes on a buge scale before that happened. Thus, major parts of d\e whole system wouki be in operation in a maionty of die slates
widun diree rars from die passage of die inirial k^oon. Inclusion of setcted large aoes in dus design is not an afterdioughc. We
believe diac what we are proposing here for die ades is die necessary complement to a large scale job-creaQon program for die ones.
Skill devebpmenc will not woric if dieie ate no jobs, but iob devebpment will not work without a determined effort to improve die
skills of diy residents. This is die skill development component
•> Parddpants
- Volunteer states, counterpart initiacive for dties.
- 15 states, 15 does selected to begin in first year, 15 more in each successive year.
- 5 year grants (on die order of $20 million per year ro each state, fower amounts ro die does) given ro each, widi specific goals
to be achieved by die diiid vear, induding pnDgram elements in place (e.g, upgraded employment service), number of people
enrolled in new professional and technical programs, and so on.
♦ Criteria for Seiecrion
- A cote set of High Ptrfotmance Woric Ot^jiizadon firms willing to parddpate in standard setting and to oflfcr training sbts
and mentors.
- Strategiesfbrenrichingexistingcooped. tech prep, other programs ro meet the criteria.
- Gammicment ro implemendng new general educaoon standard in k^isbtion.
- Commjrment ro impiementing the new Technical and Profissional skills standards for college.
- Ojmmitment ro devek>ping an outcome- arxl pertormance-based system for human resources dewefopmenc
- Commicment to new role for employment service.
- Commicment to |Oin with ocheis in national design and implemencadon activicy.
* Clients
- Young adults entering workforce.
- Disfocated workers.
- Long term unemployed.
- Empbyed who want ro upgrade skills.
•> Program Components
- Insomte own version of state and kxal labor market boards. Local labor market boards ro involve leading employers, labor
representatives, educarors and advocacv group leaders in running the redesigned empbymenc service, running incake sysrem
for all dients, counseling all clients, maintaining the informadon sysrem that will make the vendor market effiaent and
organizing employers to provide job experience and training slots for school yxiuth and adult trainees.
- Rebuild employment service as a primary function of labor market boards.
- Develop programs ro bring dropcxics and illiterate up ro general education cerdlicace standard. Organtze kxal altcnuave
pr(}vidcts and firms to provide aicemacne education, counseling, |ob experience and ptacemcni services ro these dicnis.
171
Dcvdop progianu Ibr dislocaisd woricen and hani<ore unanpkiyed (see bdow).
Develop dry- ind sace-widc programs co combine the last two vrars of high school and the ^rst two vran of colleges into
three vcar programs after acquisition of the general education certificate to culminate in college cernficates and degrees.
These programs should combine academics and structured on-the-job training.
- Develop uniform reporting system for provideis, requiring them to provide informauon in that format on characteristics of
clients, their success rates by program, and the costs of those programs. Develop computer-based system for combining this
data at local labor market board offices with employment data (Tom state so that counselors and clients can look at programs
offered by colleges and other vendors in terms of cost, client characteristics, program design, and outcomes, including
subsequent employment histones for graduates.
- Design all programs around the forthcoming general education standards and the standards to be developed by the Nadonal
Board for Professional and Technical Standards.
- Create statewide program of technical assistance to firms on high pertormance work organizadon and to help them develop
quality programs for participants in Technical and Protesionai certificate and degrce programs (it is essential that diese
programs be high quality, nonbureaucratic and voluntary for the firms).
- Panicipare with other sates, and die nadonal technical assistance prtjgram in the nadonal alliance efibn to exchange
informaaon and assistance among all partiaponcs.
^ Natxinal Technical Assistance to Parnapants
- Executive bianch authorized to compete opportunity to provide the felkwing services (probably usir^ a Request For
Qualificadons):
- State-of-the art assistance to the states and does related to the ptindpal program components (e.g.; work reorgani2aDon,
training, basic literacy, fiinding systems, apprcndceship systems, large scale data management systems, training systems for
the human resources protessionais who make the whole system work, etc). A number of organizadons would be ftinded.
Each would be expected to provide informaaon and direa assisrance to the states and ades involved, and to coordinate
their e&rts with one another.
- It is essential that the technical assistance ftincuon indude a major ptofissional devclopmenr component to make sure the
key people in the states and does upon whom success depends have the resources available to develop the high skills
required- Some of the hinds for this fiincuon should be provided directly to the states and aties, some to the technical
assistance agency.
Cooitiination of the design and implementation activides of the whole consomum, documentadon results, preparation
of reports, etc One organizadon would be ftmded to perform this fiincnon.
Dislocated Wodfen Program
"S" New legisbdon would permit combining all dislocated workers programs at redesigned emplo^Tnent service office. Clients
woukl in effixt, receive vouchers for educauon and training in amounts determmed by the benefits for which they qualify.
Employment service case managers would qualify dient worker tor benefits and assist the client in the selection of educadon
and training programs oSered by provider insutuaons. .\nv provider insutunons that receive hinds derived from dislocated
worker programs are required to pnavide informaaon on costs and performance of oroerams in uniform tormat descnbed
above. Tills consolidated and vouchenzed dislocated workers program would operate naaonwide. It wtxild be integrated
with the Collaborative Design and Dcvekapment Program in those states and aaes in which that program tuncaoned. It
would be built ait>und the general educauon certificate and the Profissional and Technical Certificate and Degree Program as
soon as those standards were in place. In this way, programs for dislocated workers would be pnjgressively and fiilly
integrated with the rest of the naoonal educadon and training system.
Levy-Grant System
•> This is the part of the system that provides funds for currently employed people to improve their skills. Ideally, it should
specifically provide means whereby front-line wotken can earn their general educadon credential (if they do not already have
one) and acquire Profissional and Technical Certificates and degrees in fields of their choosing.
♦ Everything we have heard indicates virtually universal opposition in the employer community to the proposal for a 1 and 1/2
percent levy on employers for training to support the axis associated with employed workers gaining these skills, whatever
the levy is called. The President nuy choose to press forward v^th this proposal nevertheless. .•Mtemaavely, he could cake a
leaf out of the German book. One of the most important reasons diat large German employen offer apprenaceship slots to
German youngsters is that they fear, with good reason, that if they don't volunteer to do so. the law will require it. The
President could gather a group of leading execuuvcs and business organizaaon leaders, and tell them straight our that he will
hold back on submitting legislaaon to require a tiainmg levy, provided that they commit themselves to a drive to get
employee to get their average cxpendirures on front-line employee training up to two percent of front-line employee salanes
and wages within two years. If they fiave not done so within that ame, then he will expea their support when he subnuts
legislaaon requiring the traming lew. He could do the same thing with respea to slots for structured on-the-job training.
CoUege Loan/Public Service Program
"> This proposal was a keysrone of the Clinton campaign. Because we assumed that it is bicing designed by others, we did not
fbcus on its details. From everything we know atxiut ic. however, it is enaidy compaable with die rest of what is proposed
172
here. What is, of coune, espedaily relevant here, a that our icconcepnulizaiion of the appientioeship proposal as a college-
level educadon program, cotnbuied with our proposal that everyone who gets the general education credential be endded to a
free year of higher educadon (combined federal and state funds) will have a deaded impaa on the calculations of cost for the
college loan/public service program.
Assistance for Dropouts and the Long-Term Unemployed
•> The problem of upgrading the skills of high school dropouts and the adult hard core unemployed is especially difficult. It is
also at the heart of the problem of our inner dues. All the evidence indicates that what is needed is something with all the
important charaaerisdcs of a non-residenrial Job Corps-like program. The problem with the Job Corps is that it is operated
directly by the federal government and is therefore not embedded at all in the infrastructure of Itxal communities. The way
to solve this problem is to create a new urban program that is locally — not federally — organized and administered, but
which must opeiatc in a way that uses something like the hsderal standards for contiactmg for Job Corps services. In this way,
local employers, ne^borhtxxi organizarions and other local service providers could meet the need, but requiring local
authondts to use the federal standards would assure high quality results. Programs for high school dropours and the hard-
core unemploved would probably have to be separately organized, though the services provided would b>e much the same.
Federal funds would he oSeted on a matching basis with state and local funds for this purpose. These programs should be
fully integrared with the revitalized employment service. The local labor market b>oard would be the local authority
responsible for receiving the funds and contracting with providers for the services. Ir would provide diagnosdc, placement
and tesdng services. We would etiminaie the targeted jobs credit and use the money now spent on that prtjgiam to finance
tliese operations. Funds can also lie used from the JOBS prt)gtam in the welfare reform aa. This will not be sufficient,
however, because ttiere is currendy no federal money available ro meet the neetis of haid-core unempU>yed rrules (mostly
Black) and so new momes will have to tie appropnared for that purpose.
Elementary and Secondary Education Pivgrwn
The stauuion with raptri m elemenurry and iKmAary tducaaan is very difirmtfram aduk cducatum and tmirnng. In the tatar case, a new
vmon and a whole new nrucrure is rrquxred. In thejormer. there is increasing acceptance of a new vision and structure arrtang the fmhlicat
hirge, xmthtn the relevant professional ^vups and in Confess. There is also a lot of existing activity on whuh to huiid. So our recommendaxions
here are rather more tene than in the case of adult education and tmimng.
The geneml approach here IS /Mnillel to the approach described for the Hi^ Skills for EcoriornicCornpetitiveness Progmm. Here. too. westart
with standards. And we propose a coUahomnve program with the states and with the major cities (adding m this case, areas sufinngfrom ruml
poverty) that provides an opportunity for those that wish to do so to participate m a staged voluntary and progressive implementation of the new
system. The pandlelism is deliberate. Some states and aties may wish to panwipate m both programs, developing the whole system at once, others
m only one. Much of what we propose can be accomplished through revisions to the conference report onS2 and HR 4323, recently defeated on
a cloture vote in the Confess. Solid majorities were behind the legislation in both houses of Congress.
Standard Setting
•^ Legislation to accelerate the process of national standard setting in educadon was contained in the conlcrence report on S2 and
HR 4323. The new administrauon should support the early introducdon of tins legisladon to create a Naoonal Board for
Student Acluevement Sondartls. The Board should be established as an independent not-for-profit otganizaaon chaneted by
the United States Congress. The charter should establish a self-perpetuating board of trustees for the Board chat is broadly
representatrve of the Amencan people, including reprcsentaaon of general government at all levels, education, employers, labor,
child advocacy groups and the general public. It should \x eligible to receive funds from pnvate foundadons, govemmenr
(including funds directly appropriated by the Congress), corporadons and individiials. It should bie charged with coming to a
cortsensus on content standards for the core subjects in elementary and secondary educauon and for work-related skills. We do
not believe tfiat it should be charged with developing a national otaminaaon system, but that funds should be appropnated by
the Congress to enable the E.'tecunve Branch to provide support to a vanerv of eroups that come forward to implement
exartunanon svstems based on the standards established bv the Board. The Board should tie required ro report annually to the
Congress and the pui>lk:, whether or not it receives Congressional appropnanons.
Systemic Change in Public Education: A Collaborative Design and Development Program
As we noted above, the conference reporr on S2 and HR 4323 contained a comprehensive program to supporr sysremic
change in public educauon upon which we would build. Here again, we would invite the states to submit proposals in a
competitive grant program on the same principles and for the same reasons we suggested that approach above. Each year,
additional states — and, in this case, major cities and poor rural areas — would be added to the network. Here again, most
of the existing rules and regulations affecting relevant federal education programs would be waived, save for those reladng to
health, public safety and civil rights, and the participants would be expected to specify objectives for specific demographic
groups of students and to make steady progress toward their achievement as a condition of remaining in the program. WTiile
the participants would have a lot of latitude in constructing a strategy that fits their particular context, that strategy would
have to show how they planned to;
♦ Implement an examinarion system related to the standards developed by the National Board.
♦ Empower sch<x)l staff to make the key decisions as to how the students will meet those standards.
♦ Provide auricular resources to die school staffs related to die new standards and examinauons.
♦ [Organize pre-service and in-servKe profissional development prt)grams to support die development of the skills necessary to
bnng all students up to the new standards.
♦ Reorganize the delivery of healdi and social servKes to children and their tamilies so as to support students and die schtxil
faculties.
173
^ Dq^loy advanced technok)giesiDsuppon the learning of soiclcna in and oui of school
*^ R^CTnif-nimm^nrgjnrrjtv^n jrvH tnjnjgmvnr nf pnhlir i-Wnmrary jnfl annrv43ry fftiK-jrinn r»n rty prinripl^-^ nf fnor^<^m
qualicy management, empowcnng school saS, reducing iniennediaie \xym of bu/eaucncy and d>e burden ot rules and
reguladons irom die soie, dK board of educadon and die unions and holding school staiFaccouncabIc for student progress.
Funds provided by this program could be used for professional development, to provide critically needed glue' support to
weld together activities consistent with the purposes of the program, and to provide student services. But funds for direct
student services could be used only for services rendered before and after the regular school day, on weekends and during
vacauon periods. States receiving funds under this program would have to provide relief from regulation comparable to that
provided by the federal government.
Federal Programs for the Disactvantagcd
•> Ihe established federal cducaoon programs tor the disadvantaged need to be diotoughly overhauled to reflea an emphasis on
results for the students rather than compliance with the rcguladons. A riadonal commission on Chapter 1, the largest of these
programs, chaired by David Hombeck. has designed a radically new version of this legisbdon. with the acnve parncipadon of
many of the advocacy groups. Other groups have been similarly engaged. We think the new administradon should quickly
endorse the work of the national commission and intrtxluce its proposals early next year. It is unlikely that this legisbaon will
pass betbtr the deadline — two years away — for the neauthorizauon of the Elementary and Secondary Educaaon Aa. but early
endorsement of this new apprt>ach by the administiaaon will send a strong sigrul to the Congress and will grcady aiica the
climate in which other parts of die aa will be considered.
Public Choloe, Teduotogj^ Incenated Heahii and Human Service*, Cunkulum Rooiuces, High Peifuiiuance Managemeni,
Protrwintwl Dndopmoit and Raeaicfa and Development
♦ The restructunng of the schools that wr envision is noc likelv to succeed unless the schools have a k)t of information about how
to do it and real assistance in gemng it done. The areas in which dus help is needed ate siiayqni bv die heading for dus section.
One of the most cost-«fiective things the fodeial government could do is to provide suppon for research, devekjpmeni and
oechnicai assistance to the schools on these topics. The new Secretary of FHiicanon should be direcied to propose a strai^ for
doing just that, on a scale sufikicnt to the need. Existing programs of research, development arvd assistance should be examined
as possible sources of fiinds for these purposes. Professional development is a speaal case. To build the rcstrucnuvd system will
require an enormous amount of professional development and the time in which professionals can take advantage of such a
resource. Both cost a lot of money. One of the prionoes for the new educadon secretary should be the development of strategies
for dealing with these problems. But heie, as elsewhere, there arc some ousting programs in the Department of Educadon whose
fondj^an be redirected for this purpose, programs that are not currently informed by the goals that we have spdled out. Much
of what we have in mind here can be accomplished through the reauthotizadon of the OfGce of Educanonal Researdi and
Improvement.
Early Childhood Education
4" ThePresident-Elect has committed himself to a great expansion in the fonding of Head Start. We agree. But the design of the
program should be changed to reflect several important requirements. The quality of professional prcparanon for the people
who staff these programs is ^rry k)w and there are no standands that apply to their employment. The same kind of standard
setnng we have called fot in the rest of this plan should inform the apptoach to this ptogtam. Early childhood educaaon shoukl
be combined with quality day care to provide wrap-around pft>grams that enable working parents to drop off their children at
the beginning of the work day and pick them up at the end. Full fonding for the very poor should be combined with matching
funds to extend the tuidon paid by middle-class parents to make sure that diese programs ate not officially segregated by income.
The growth of the prf>gram should be phased in, ratfier than done all at once, so that quality' problems can be addressed along
the way, based on developing examples of best piacnce. These and other related issues need to be addressed, in our judgment,
before the new administradon commits itself on the specific fotm of increased suppon for Head Start.
Putting the I^Kkage Togethen
Herr we TrrTond the ittuier of what we uud as the begmning about the packaging of this agenda. We propose thai the idtasjust Jescnhed be
assembled into four high priority packages:
1. The first would use the Clinton proposal for an apprennceship system as the keystone of the strategy Jbr putting the whole new
postseamdary tramtng system in place. It would consist of the proposal for postsecondary standards, the OiUahomnve Design and
Development proposal the technical assistance proposal and the postsecondary education finance proposal
2. The second would combine the initiatives on dislocated workers, the rebuilt empbymem service and the new system of labor market
hoards as the Clinton admmismmoris employment security prognxm, built on the best practices anywhere in the world This is the
backbone of a system fi>r assuring ndulr workers in our society that they need never again watch with dismay as their jobs disappear and
their chances of ever getting a good job again go with them.
3 The third would concentrate on the overwhelming problems of our inner cities (and at the school level poor rural areas), combining
most of the elements of the first and second packages into a special propam to greatly raise the work-related skills of the people trapped in
the core of our great aties.
4. Thefmrth would enable the new adrmrusmition to take advantage of legislation on which Confess has already been working to
advance the elementary and secondary reform agmda. It would combine the successor to HR 4323 and S2 (incorporating the systemic
refi)rm agenda and the board fjr student perfirmance standards) with the proposal ffr revamping Chapter I.
174
National Center on Education and the Economy
Board of Trustees
Mano M. Cuomo, Honorary Chair, Governor of New York.
Albany. New York
John Sculley, Chair. Chairman and Chief Bcecutive Officer,
.•\ppie Computer, Inc, Cupertino, California
James B. Hunt, Jc, Vice Chair, Parmer, Poyner &L SpniiU and
Govcmor-Elea of North Carolina. Raleigh, North Carolina
R. Carlos Carballada, Treasurer, Chancellor. New York Sate
Board of Regents and President &C Chief Lxecuuve Officer, First
National Bank, Rochester. New York
Marc S, Tucker, Prendent, National Center on Education and
the Economy, Rochester, New York
Anthony P. Camevale, President. Insucute for Workplace
Learrung, American Society for Training & Development,
.■Mexandria. \'irginia
Sarah H. Cleveland, Law Clerk. United States Distria Coun.
Washington, DC
Thomas W. Cole, Jt, President. Clark Atlanta Universitv, .Adanta.
Georgia
Philip H. Power, Chairman. Suburban Commuiucadons
Corporanon. .■\nn Arbor. Michigan
Lauren B. Resnlck, Direaor. Leaming Reseaxch and
Development Center, University of Pittsburgh. Pittsburgh.
Penns^^vania
Manuel J. Rivera, Superintendent, Rochester City School
Distria. Rochester, New York
David Rockefeller, Jt, Chairman, Rockefeller Financial
Services, Inc., New York, New York
Adam Urbanski, President, Rochester Teachers .Associadon,
Rochester, New York
Kay R. Whitmore. Chairman. President & Chief Executive
Officer. Eastman Kodak Company, Rochester, New York
VanBuren N. Hansford, Jr„ Chief Executive Officer and
Chairman, Hansford Manulactunng Corporation. Rochesrer,
New York
Louis Harris, Chairman, LH Research. New York. New York
Guilbert C Hentschke, Dean, School of Education, University
of Southern California, Los .Angeles, Califonnia
Vera Kaiz, Mayor-Elect, Portland, Oregon
Arturo Madrid, President, The Tomas Rivera Center. Claremont,
California
Ira C Magaziner, President, SJS, Inc.. Providence, Rhode Island
Shirley M. Malcom, Head, Directorate for Education and
Human Resources Programs, .American .Association for the
.Ad%-ancement of Science. Washington, DC
Ray Marshall, Audre and Bernard Rapoport Centennial Chair in
Economics & Public .Afiairs, L.B.J. School of Public Afiiurs,
University ofTexas at Ausnn, Austin, Texas
Richard P. Mills, Commissioner of Education. Vermont
Department ol Education, .Montpelier. Vermont
175
PREPARED STATEMENT OF JAMES D. WEILL
The Children's Defense Fund (CDF) greatly appreciates the opportunity to testify
here today. This committee has provided important leadership over the years in direct-
ing attention to the needs of low-income children and families.
Much of the economic debate going on in our country today centers on the deficit,
and on the size and scope of the forthcom.ing stimulus package. These are very impor-
tant concerns. Our nation needs to attain strong economic growth again. And getting
control over the deficit is central to building and sustaining the long-term economic
health of the nation.
Equally central to the long-term economic health of the nation, however, is meeting
the needs of our children and families. Neglecting an out-of-control deficit certainly
subverts our economic and social future. But neglecting the desperate needs of millions
of American children just as certainly subverts our economic and social future. Ill-fed,
undereducated, unhealthy and increasingly alienated generations of future workers,
parents and voters will not grow the economy, sustain Social Security's intergenera-
tional promise, maintain a strong defense or nurture our democracy no matter how
small the deficit is.
Therefore, our nation must take the steps needed to assure that no child is left be-
hind. We must focus considerably more resources on families and children so that our
nation remains strong and competitive in the 21st century.
Child Poverty
The American dream is collapsing all around America for millions of families,
youths, and children in all races and classes. We are in danger of becoming two nations
- one of first world privilege and another of Third World deprivation - struggling
against increasing odds to co-exist peacefully as a shrinking middle class barely holds
on. While the middle class has lost ground, more children and famOies have fallen into
poverty and the poor have become poorer, more desperate, hungry, homeless, and
hopeless.
Today children, and especially very young children, are the poorest Americans.
Children are almost twice as likely as any other age group to be poor. More than 14
million of our children -- one in five children (and one in four preschoolers) ~ are poor.
As recently as the late 1960s, poverty rates for children were much closer to those
for working age adults and lower than those for the elderly. This pattern was reversed
in the 1970s and 1980s, with children becoming by far the poorest of all Americans. As
Senator Moynihan has said, we may be the first society in history to have made children
its poorest members. This is a unique act of self-destruction. There are more poor chil-
dren in America today (14,341,000) than in any year since 1965, despite the 88 percent
real growth in our Gross National Product (GNP) during this period. Moreover, child
poverty is a pervasive national problem, not an isolated one. Contrarv' to popular myth,
a majority of poor children are not black; a majority live in working families; and a ma-
jority live outside inner cities in small town, rural, and suburban America.
There are more poor children in rich America than there are citizens in famine-
stricken Somalia; more in Los Angeles and New York City than there are in the "devel-
oping" nation of Botswana. It is a great human and moral tragedy that thousands of
children and adults have starved to death in poor, war-torn Somalia with a per-capita
income of less than $200 a year and an estimated GNP of $1.6 billion. It is a human
and moral travesty that over 14.3 million American children are poor, and that an esti-
mated 5 million go hungry in a nation with a per-capita income of $19,700 and a Gross
Domestic Product of $5.9 trillion.
Child Poverty And Economic Cycles
Our nation's astronomical chOd poverty rates are not just the result of the recession
and will not be solved just by economic growth. They are also the result of falling
wages, growing numbers of part-time and temporary jobs, growing family instability.
176
and a host of other stmctural problems that have unfortunately survived recent reces-
sions and lingered during growth periods.
Despite uninterrupted economic growth from the end of 1982 through 1989, the
number of children in poverty increased by more than 2.2 million in only a decade
(from 1979 to 1989). In earlier eras some children fell into poverty during recessions,
but larger numbers of them escaped poverty during recoveries. In recent years, how-
ever, children have been hurt more by recessions and have become less and less likely
to bounce back during periods of economic recovery. This switch in the impact of U.S.
economic cycles has devastated families with children.
The recessions of the 1970s were much deeper than the single recession of the
1960s, pushing children into poverty at a rate of more than half a million per recession
year. The impact of recessions on children grew even worse in the 1980s, adding an
average of 884,000 children annually to the ranks of the poor. And during the
1990-1991 recess ion's low growth period, more than 875,000 children were added to
the ranks of the poor each year.
In turn, economic recoveries have lost their ability to rescue children from poverty.
During the 1960s, growth periods lifted more than 900,000 children annually out of
poverty. In the 1970s and 1980s this rate dropped to fewer than 300,000 annually. In-
deed, in 1989, the last year of the economic recovery before the recession, the number
of children in poverty actually grew.
In short, the impact of full economic cycles of recession and recovery has changed.
Child poverty rates now ratchet upwards rather than fall down with each successive full
cycle. If the pattern of the 1980s holds true in the 1990s, nearly one quarter of the na-
tion's children will be poor at the end of the century.
The Costs Of Child Poverty - For Children And The Nation
Our astronomical rates of child poverty are a tragedy not just for the children in-
volved, but for the nation as a whole. Poor children disproportionately suffer an ero-
sion of their health, their abilities, their hopes, and their spirits. The nation suffers an
erosion of its future.
For some children, the consequences of poverty can be deadly. Several years ago
the Maine Health Bureau found that poor children were more than three times as likely
as other children to die during childhood, and estimated that 10,000 children die from
poverty in the United States each year. The vast majority of poor children do not die
from poverty, but their health and development and eventual capabilities and produc-
tivity as workers, parents, and citizens often are damaged by the deprivations of grow-
ing up poor.
From the earliest years of life to the verge of adulthood, poverty places its child
victims at higher risk of a host of problems, many of which will follow them throughout
their lives. Prematurity, low birth weight, birth defects, infant death and other bad
health outcomes are linked to low income, low educational level, low occupational
status, and other indicators of social and economic disadvantage. Poverty is also often
associated with significant developmental limitations, with growth retardation, and with
blood lead levels sufficient to place children at risk for impaired mental and physical
development.
Poor children are less likely to receive key building blocks of early development --
adequate nutrition, decent medical care, a safe and secure environment, and access to
early childhood development programs to supplement learning opportunities in the
home. They are far more likely to be hungry and those who are hungry are more likely
to suffer fatigue, dizziness, irritability, headaches, ear infections, frequent colds, un-
wanted weight loss, inability to concentrate, and increased school absenteeism.
Poor children are far more likely to have below-average basic academic skills and
fall behind in school, to repeat grades, and to drop out of school. Girls who are poor
and who have below-average basic academic skills, regardless of their race, are five and
a half times more likely to have children during their teenage years than nonpoor teen-
agers with average or better basic skills.
177
Poverty also means more homelessness, more substance abuse, more crime, more
violence, more racial tension, more enw, more despair and more cynicism -- a long-
term economic and social disaster not just for children but for the country. In virtually
every critical area of child development and healthy maturation, family poverty creates
huge roadblocks to individual accomplishment, future economic self-sufficiency, and
national progress.
There are profound effects on children and the nation every hour of every day:
• Every 12 seconds of the school day, an American child drops out (380,000 a
year).
• Every 13 seconds, an American child is reported abused or neglected (2.7 million
a year).
• Every 26 seconds, an American child runs away from home (1.2 million a year).
• About every minute, an American teenager has a baby.
• Every 9 minutes, an American child is arrested for a drug offense.
• Every 40 minutes, an American child is arrested for drunk driving.
• Ever)' 53 minutes in our rich land, an American child dies from poverty.
• Every 3 hours, a child is murdered.
Our high child poverty rates, aside from being a moral abomination, make it far
more difficult to solve a host of these and other social problems afflicting children,
their families, and the nation. Child poverty is weakening our nation and subverting its
future.
By many measures of children's well-being, America's performance compared with
that of its allies and competitors is dismal. Our nation's rank in combating infant mor-
tality has dropped to only 20th in the worid. We are 31st in avoiding low-birthweight
births. And once in school, our students fare poorly on tests of educational achieve-
ment compared with their peers in other nations. High child poverty rates play a key
role in all of these lags and represent a growing threat to our future strength and eco-
nomic competitiveness.
Young Families And The Economy
Much of the increase in child poverty, much of the sense of growing economic inse-
curity, and much of the economic turmoil of the last two decades have been concen-
trated among America's young families.
Young families with children -- those headed by persons under the age of 30 - have
been devastated since 1973 by an unprecedented and almost unimaginable cycle of
falling incomes, increasing family disintegration, and rising poverty. In the process, the
foundations for America's young families have been so thoroughly undermined that two
complete generations of Americans - today's young parents, and their small children -
are now in jeopardy.
Young families are the crucible for America's future and America's dream. Most
children spend at least part of their lives -- their youngest and most developmentaUy
vulnerable months and years -- in young families. How we treat these families therefore
goes a long way toward defining what our nation as a whole will be like tu'enty, fifty,
and even seventy- five years from now, economically, culturally and politically.
Adjusted for inflation, the median income of young families with children plunged
by one-third between 1973 and 1990. This figure includes income from all sources, and
the drop occurred even though many families sent a second earner into the workforce.
As a result, poverty among these young families more than doubled, and by 1990 a
shocking 40 percent -4 in 10 - chOdren in young families were poor.
The past two decades have been difficult for many other Americans as well. But
older families with children have lost only a little economic ground since 1973, and
families without children have enjoyed substantial income gains. In effect, the nation's
economic pain has been focused most intensively on the weakest and most vulnerable
among us -- young families with children.
178
Again, this is not a stor\^ about the recent recession, although the recession surely
had a crushing impact on young families. Even comparing 1973 to 1989 -- two good
economic years at the end of sustained periods of grouth -- the median income of
young families with children dropped by one-fourth. Then just the first few months of
the recession in 1990 sent young tamilies' incomes plummeting to new depths.
This also is not a story about teenagers. While America's teen pregnancy problem
demands an urgent response, only 3 percent of the young families with children we are
discussing are headed by teenagers. More than 70 percent are headed by someone aged
25 to 29. The plight oi America's young fanryilies is overu'helmingly the plight of young
adults who are old enough to assume the responsibilities of parenthood and adulthood,
but for whom the road often is blocked.
Finally and most importandy, this is not simply a stor\' about minority children, or
children in single-parent families, or children whose parents dropped out of high
school.
Huge income losses have affected virtually ever>' group of young families with chO-
dren: white, black and Latino; married- couple and single-parent; and those headed by
high school graduates as well as dropouts. Only young families with children headed by
college graduates experienced slight income gains between 1973 and 1990.
In other words, the economic and social disaster facing young families unth chil-
dren has now reached virtually all of our young families. One in four white children in
young families is now poor. One in five children in young married-couple families is
now poor. And one in three children in families headed by a young high school gradu-
ate is now poor. Neariy three-fourths of the increase in poverty among young families
since 1973 has occurred outside the nation's central cities. And poverty has grown most
rapidly among young families with only one child.
Young families not only have lost income in huge amounts, but as the permanence
and quality of their jobs deteriorated, they have lost fringe benefits like health insur-
ance as well. In the decade of the 1980s the proportion of employed heads of young
families with children whose employers made health insurance available by pacing all or
part of the cost dropped by one-fifth. And employers cut back on coverage for depend-
ent spouses and children even more than for workers.
Because they are poorer and less likely to have adequate insurance or any insur-
ance, fewer and fewer young pregnant women have been getting adequate prenatal
care. And our falling vaccination rates and renewed epidemics of measles and other
wholly preventable diseases among preschoolers are being driven not just by skyrocket-
ing vaccine prices, but by plunging incomes in young families, eroding health insurance
coverage and unraveling government programs.
Falling incomes also have devastated young families in an increasingly expensive
housing market. One-third fewer young families uith children were homeowners in
1991 than in 1980. Young renter families increasingly are pa>'ing astronomical shares of
their meager incomes for rent. More and more are doubling up or becoming homeless
- in some surveys three-fourths of the homeless parents in this country are under age
30.
Young families are not only suffering in absolute terms. They are suffering in rela-
tive terms as well, because they are falling further and further behind their parents a
generation earlier and behind the rest of the societ)' now -- imperiling their attachment
to the core work force and to mainstream values and threatening their potential to
reacquire the American dream in the decades to come.
In 1973 the median income of older families with children was not quite 1 and 1/2
times that of young families with children. By 1990 it was more than double that of the
young families.
There is no single cause of young families' plight. They have been pummel led by a
combination of profouned changes in the American economy; the government's inade-
quate response to families in trouble; aned changes in the composition of young fami-
lies themselves. These changes have hurt all young families with children, regardless of
their family structure, race or ethnicity, or educational attainment.
179
Unlike members ot earlier generations, young workers today no longer can be con-
fident of finding stable jobs with decent wages, even if they get a high school diploma
or spend a couple of years in college. Since 1973, slower growth in U.S. productivity
and declines in blue collar employment may have made some drop in inflation-adjusted
median earnings tor some groups ot workers inevitable. By 1991 the average wages of
all nonsupen'isory workers (of all ages) in the private sector fell to their lowest level
since the Eisenhower Administration. But the losses have been focused disproportion-
ately on young workers.
The median annual earnings of heaeds of young families with children fell a stag-
gering 44 percent from 1973 to 1990. In other words, in the span of less than a genera-
tion this nation nearly halved the earnings of young household heads with children.
These dramatic earnings losses occurred across-the- board. Young white families with
children were hit as hared as young Latino families: the median earnings of both
groups tell by two-fifths. College graduates as well as high school graduates and drop-
outs lost big chunks of income. But the drop in median earnings for high school edrop-
outs and tor young black family heads has been particularly devastating - in each case
more than two-thirds.
The erosion in pay levels (due in part to the declining value of the minimum wage)
combineed with the growth of temporary or part-time and part-year jobs to put a triple
whammy on young workers: far lower annual earnings; less secure employment; and
less access to health insurance and other employer-provided benefits.
The huge drop in earnings among America's young workers has been partially ob-
scured by the almost Herculean work effort of young parents. Many young married-
couple families have tried to compensate for lower wages by sending a second worker
into the work force. These second earners have softened (but not eliminated) the eco-
nomic blow. But the growing number of young parents working longer hours or coping
with two jobs has placed families with children under tremendous stress and generated
new offsetting costs, especially for child care. Many families, moreover, have two jobs
that together provide less security and less support and less access to health care than
one good job did a generation ago.
In addition, this two-earner strategy is totally unavailable to the growing number of
single-parent families. The growth in the number of young female-headed families with
children is in part a reflection of changing values. But the economic hardships associ-
ated with falling earnings and persistent joblessness among young adults also have con-
tributed significantly to falling marriage rates and the increasing rates of
out-of-wedlock childbearing.
The capacity to support a family has a powerful impact on the marriage decisions of
young people. More than two centuries ago Benjamin Franklin wrote: "The number of
marriages... is greater in proportion to the ease and convenience of supporting a family.
^X^^en families can be easily supported, more persons marry, aned earlier in life."
The changes of the last two decades have had a very profound impact on minority
young famOies, especially those that are black. The median earnings of the heads of
young black families with children fell 7i percent from 1973 to 1990 (from $13,860 to
$4,030 in 1990 dollars). Their total famOy incomes from all sources fell 48 percent. The
median income of these young black families is now below the federal poverty line for a
family of three. In 1973 it was nearly double that poverty line. Two out of three chil-
dren in young black families now are poor.
This crisis for young black families is contributing mightily to the tearing apart of
the black community. Growing poverty and isolation and hopelessness in turn show up
in the emergency rooms and unemployment lines and prisons and homeless shelters
and neonatal intensive care wards and morgues of our cides and our suburbs and rural
towns. They show up in the growing violence that destroys so many black lives. More
blacks die from firearms each year in this country than died in the century's worth of
despicable lynchings that followed the Civil War.
But young white families are only a step or two behind in the scope of theirec
onomic depression and family disintegration. Two decades of this depression for the
180
young have had a devastating impact on many types of families we often assume are
insulated from hard times. From 1973 to 1990 the poverty rate for children living in
young white families more than doubled to 21 percent.
A generation ago white or married-couple young families or those headed by high
school graduates were fairly well insulated from poverty. The damage of the last two
decades has cut so broadly and deeply that now one in four white children in young
families, one in five children in married-couple young families, and one in three chil-
dren in families headed by young high school graduates is poor.
In 1990 a child in a family headeed by a parent under age 30 was:
• twice as likely to be poor as a comparable child in 1973;
• if living with both parents, two and a half times as likely to be poor as in 1973;
and
• nearly three times more likely to have been born out-of-wed lock than his coun-
terpart two decaedes ago.
But despite the devastating suffering these numbers suggest, children in young
families have been given less and less government help over the last two decades. They
were getting less to begin with -- government programs are particularly stingy when it
comes to helping younger adults and young children. And in the 1970s aned especially
the 1980s young families saw programs that might help them cut rather than strength-
ened and reconf igured to adapt to new realities. As a result, government programs
were less than half as effective in pulling young tamOies out of poverty in 1990 as in
1979.
Eliminating Child Poverty And Strengthening The Nation
Child and famOy poverty in America in the 1990s is not inevitable. Indeed, the na-
tion can no longer afford to have such widespread child poverty -- economically, so-
cially, or morally.
The nation now has more than adequate resources and ability to conquer the child
poverty that persists and grows amidst broader affluence. In fact, America has never
been more capable economically of eliminating child poverty. Despite the picture many
would sketch of a nation crippled by budget deficits and lacking the resources to tackle
its fundamental problems, America's income -- as measured by the Gross National
Product (GNP) - will be at an all-time high in 1993.
The nation's success in lifting older Americans out of poverty during the past three
decaedes offers compelling evidence that the nation has the knowledge and ability to
edramatically reduce poverty if it chooses to. The poverty rate for persons 65 and older
was slashed by nearly two-thirds between 1967 and 1989. During the 1980s, when
child poverty soared, the poverty rate for older Americans steadily declined, dropping
nearly one-fourth. Poverty is still too high among older Americans, but the nation's suc-
cess story in combating poverty among the elderly is instructive and heartening.
For a period in the 1960s, the nation also made dramatic progress in reducing child
poverty. Child poverty rates were cut in half in a single decade, falling from 21 percent
in 1960 to 14 percent in 1969. Poor children were aided by a combination of robust
economic growth and concerted public action. But then progress was halted during the
1970s and child poverty rates moved upwards again in the 1980s.
Four decades ago Senator Robert Taft (R-Ohio) said: "I believe that the American
people feel that with the high production of which we are now capable, there is enough
left over to prevent extreme hardship and maintain a minimum standard floor under
subsistence, education, medical care and housing, to give to all a minimum standard of
decent living and to all children a fair opportunity to get a start in life."
We must re-establish the belief of this distinguished conservative Senator as a be-
lief and goal for all Americans. This nation is four times as wealthy as when Senator
Taft spoke these words four decaedes ago. What we were capable of two generations
ago we are far more capable of today. Our per capita GNP is higher than that of most
of our European competitors, which have much lower child poverty rates.
181
America is afflicted by a poverty of riches unleavened by enough justice. Our ex-
traordinarily high child poverty rates are not some unavoidable attribute of modem,
urbanized societies or act of God. They are highly unusual and represent conscious
value and political choices. Our children are two to 14 times more likely to be poor
than the children of Australia, Canada, Sweden, Germany, the Netherlands, France,
and the United Kingdom.
We can make other and better choices. Young families are our early warning signal,
our glimpse of what will happen to all American families if we continue on our present
course. That is why we must target families with children, and especially young families
with our youngest and most vulnerable children, for new initiatives to give them the
strong foundation they need.
We should start with those things that we all know work, where there is extraordi-
nary support and consensus that public investments can make a difference.
Our first priority should be to guarantee full funding of an improved Head Start
program that reaches all eligible children while also meeting the needs of working par-
ents.
If we are serious about the national goal of making all children ready for school, we
must make good on our long-overdue promise to give every poor preschooler a Head
Start. Support for more full-day, full-year programs, key quality improvements, strong
parent involvement and support, and new efforts to reach infants and toddlers when
appropriate must be part of this major new Head Start initiative.
A second area where we have overwhelming consensus and the basis for quick ac-
don is on a highly visible campaign to get all American children immunized. Despite
the importance of getting children off to a healthy start in life, our record in immuniz-
ing children against preventable diseases is absymal - fewer than 60 percent of Ameri-
can preschool children are fully immunized, and rates are as low as 30 percent in some
states. If El Salvador could suspend a civil war for three separate days every year for
seven years so that children could be immunized and if China, still among the twenty
poorest countries in the world, can reach an immunization rate of nearly 95%, there is
no excuse for the American failure to reach all children. A sweeping U.S. immunization
effort would cost little, but the long-term savings - measured in dollars and in lives -
would be great.
Head Start and immunizations are the first places to start investing in the next gen-
eration, because they enjoy universal support, because they lay the groundwork for fu-
ture success, and because they focus help on the youngest and neediest children. But
there are many other cost-effective ways that we can build strong families, attack child
poverty, create a workforce that is able to compete in the rapidly changing global econ-
omy, and save our nation's future.
We can ensure that our children and youth grow into healthy and productive adults
by including comprehensive coverage for all children and pregnant women in any na-
tional health care reform plan.
We can provide jobs and valuable work experience for teenagers and adults uath
limited skills by including community revitalization and human service projects in any
economic stimulus or infrastructure initiative.
We can increase training opportunities for our most disadvantaged youth by ex-
panding the successful Job Corps program along the lines proposed in the Job Corps
"50-50 Plan" and by launching new youth apprenticeship, community service and other
vocational training efforts.
We can rescue families in crisis -- and thereby bolster the eventual self-sufficiency
of both parents and children -- by quickly enacting the Family PreservaUon Act passed
by the last Congress as part of the urban aid bill but vetoed.
We can ensure that parents and especially parents who work can support their
families. We made a start with the Family and Medical Leave Act. Now we must move
toward expansion oi the Earned Income Credit; regular adjustments in the federal
minimum wage; stepped up child support activity and creation of a child support
182
assurance system; enactment of a refundable children's tax credit for hard-pressed low-
and middle-income families; and welfare reform that protects needy children while fix-
ing the anti-family, anti-work attributes of our current welfare system. Ending welfare
as we know it will require as well substantial chOd care supports for parents, improved
job training, and creation of decent jobs for parents moving away from welfare depend-
ence.
While we address the slow, grinding violence of poverty that takes an American
child's life every 53 minutes, we must also address the deadly, quick violence of guns
that takes an American child's live every three hours and the lives of 25 children -- the
equivalent of a classroomful - every two days.
The deadly combination of guns, gangs, drugs, poverty, and frightened, hopeless
youths is turning many of our inner cities into Vietnams of destruction and despair and
our neighborhoods and schools into corridors of fear. Prison walls are bulging with the
1.1 million inmates that make us the world's leading jailor. Yet violence escalates. For
thousands of children and young adults, the American dream has become a choice be-
tween prison and death. In fact, prison has become a more positive option than home
and neighborhood for many youths who see no hope, no safety, no jobs, and no future
outside prison walls.
A new spirit of struggle must arise across our land today to stop the neglect of chil-
dren and end their poverty. Every American - leader, parent, and citizen, led by our
new president and Congress - must struggle to reclaim our nation's soul and give our
children back their hope, their sense of security, their belief in America's fairness, and
their ability to dream about, envisage, and work towards a future that is attainable and
real. Only in that way will we assure the nation's future economic security.
183
PREPARED STATEMENT OF ISSAC SHAPIRO
Mr. Chairman, thank you for the opportunity to testify here today. I am a senior
research analyst at the Center on Budget and Policy Priorities. The Center is an inde-
pendent, nonprofit research and analysis organization that focuses on public policy is-
sues affecting low and moderate income Americans. My statement is based largely on a
forthcoming report on policies to assist the working poor that I am coauthoring with
Robert Greenstein, the Center's director.
Investments in children and in education and training will fully pay off only if im-
provements are also made in the returns to work for low-wage employees. The wages of
the typical non-management worker have been falling for some time and the problems
of the working poor have been rising. A better prepared work force can help reverse
these trends, but direct steps to boost wages are needed as well. I will focus my re-
marks on two such steps: increases in the Earned Income Tax Credit and the minimum
wage.
The Backdrop
Wage erosion has become a difficult fact of life for a large share of the American
work force. After adjusting for inflation, the average wage for private, nonsupervisory
workers is now at its lowest level since the mid-1960s.
The problem has become even more acute for low-wage workers. A recent Census
Bureau report found that between 1979 and 1990, the proportion of full-time year-
round workers paid wages too low to lift a family of four to the poverty line increased
dramaticaOy. Some 12.1 percent of full-time workers were paid wages this low in 1979;
by 1990, some 18 percent earned this little. Of note, the report found that the propor-
tion of workers with low earnings rose about two-thirds for workers of all educational
backgrounds.'
Consistent with these trends, both in absolute numbers and as a share of the pov-
erty population, the working poor remain a disturbing social problem. The combination
of work and poverty is particularly prevalent among families with chOdren.
In 1991, some 9.2 million workers were poor, 2.1 million of whom worked full-time
year-round.
• A far larger number of poor people lived in families that contained at least one
worker. An estimated 20 million people - some 56 percent of the poor - lived in
households where someone worked during the year.
• Nearly two-thirds of all people living in poor families with children - or 15 million
such people - lived in families with a worker. And 5.5 million people living in
poor families with children were part of a family containing a member who
worked full-time year-round.
These figures reflect substantial work effort on the part of a large segment of the
poverty population. In 1990, a majority of working poor families with children con-
tained members employed for a total of eight or more months of full-time work.^
The overall trend among the working poor is not encouraging; today workers are
just as likely to fall into poverty as in the past. This can be shown by following the stan-
dard practice of comparing equivalent years in the economic cycle. Data from 1991, the
last year for which 'poverty data are currently available, can be compared to data from
1980. Unemployment rates were roughly the same in both years, and the economy was
in recession for at least part of each year'
' U.S. Department of Commerce, Bureau of the Census, Workers With Low Earnings: 1964 to 1990, Series P-60,
No. 178, March 1992.
Seven of every ten working poor families with children had someone employed for the equivalent of five or
more months of full -time work. In these calculations, the number of hours worked by all family members is
combined. The figures used in the text assume a full-time work week equates to 40 hours of employment. See
U.S. Congress, House of Representatives, Comnnittee on Ways and Means, 1992 Green Book: Background Mate-
rial and Data on Programs Within thin the Jurisdiction of the Committee on Ways and Means, May 15, 1992, p. 1282.
' The unemployment rate averaged 6.7 percent in 1991, a little below its 7.1 percent average in 1980. The Gross
184
In 1991, some 6.9 percent of all workers were poor. In 1980, 6.7 percent were
p)oor. Similarly, in 1991, some 2.6 percent of full-time workers were poor, essentially
the same as the 2.5 percent rate in 1980.
The trend among families with children is more adverse. Some 9.1 percent of fami-
lies with children in which the head-of-household worked were poor in 1980. By 1991,
the poverty rate among these families had risen to 1 1.2 percent.
The Goal: Making Work Pay
To address the problems of the working poor, there has been growing support for
the notion that policies need to be devised to "make work pay." In particular, liberals
and conservatives alike have coalesced around the goal that work should pay suffi-
ciently so that individuals employed full-time should not be poor.
President Clinton, too, has expressed emphatic support for this goal. As he stated
in a major policy address just last week: "We have to make sure that every American
who works full-time with a child in the home does not live in poverty. If there is dignity
in all work, there must be dignity for every worker.""*
The agenda for the working poor is a full one. It includes addressing the problems
of affordable child care and access to health care. It also includes helping the working
poor who fail to qualify for important benefits such as food stamps because of overly
stringent asset limits. A description of these and several other initiatives lies beyond the
scope of my remarks. Instead, I will concentrate on reforms to two key policies that
affect the returns to work: the Earned Income Tax Credit and the minimum wage.
President Clinton has endorsed strengthening both policies.
Reforms To The Eic And The Minimum Wage
The goal that families with full-time workers should not be poor is generally de-
fined as meaning that families with a worker employed full-time at the minimum wage
should be able to escape poverty, once the benefits provided under the federal Earned
Income Tax Credit are counted.
The Earned Income Tax Credit has become one of the most important government
supports for poor workers. In 1992, nearly 14 million families received EIC benefits
totaling $11.4 billion.
An important feature of the EIC is that it is refundable. This means that to the ex-
tent a family's EIC benefit exceeds its federal income tax liability, the IRS send the
family a check for the difference. Since the working poor usually do not owe federal
income tax, nonrefundable tax credits are of little or no benefit to them.
The EIC is popular across the political spectrum. One reason for this is that the
credit is considered strongly "pro-work." Families without a working parent do not
qualify for it. Moreover, unlike welfare benefits, which fall sharply as earnings rise and
thereby discourage work, EIC benefits increase with each additional dollar earned by
the very poor. Consequently, the EIC strengthens the incentive to work for those work-
ing litde or not all.
Another feature accounting for the credit's popularity is that it is considered "pro-
family." It is provided only to parents who live with their children more than half the
year. Absent parents are not eligible.
Under the basic EIC, in 1993, a family with one child will receive a credit of 18.5
cents for each dollar of its first $7,750 in earnings. When a family's earnings equal
$7,750, a family with one child will qualify for the maximum credit of $1,4M. The
credit remains at this maximum level until a family's earnings surpass $12,200. At that
point the benefit begins to be phased out; once a family's income reaches $23,050, the
credit falls to zero. Iliere is a second, slightly larger, credit level for families with two or
more children.
Domestic Product, the basic measure of the siEe of the economy, declined 0.7 percent in 1991, very close to its
1980 decline of 0.5 percent.
" Remarks by the President to the National Governors Association Winter Session, February 2, 1993.
185
The EIC was expanded sharply in 1990; this latest expansion is now phasing in and
will take full effect in tax year 1994. In that year, the maximum credit will rise to 23
percent of earnings for families with one child and 25 percent for families with two or
more children.'
While the minimum wage was also raised recendy, it fared far less well than the
EIC during the 1980s. The minimum wage remained at $3.35 an hour from January
1981 through March 1990; during this period, the cost of living rose 48 percent. Legis-
lation enacted in 1989 raised the wage floor in two steps - in April 1990 and April 1991
- to its current level of $4.25 an hour. These increases made up less than half of the
ground lost to inflation during the 1980s. (See Figure 1.)
Figure 1
Minimum Wage vs. Poverty Line for a Family of Three
(Earner Works FuU-Time Year-Round)
Percent of 3-Person Poveny Line
0
I960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993
Year
Poveriv Line
Mm Wage Earnings
As a result, the value of the minimum wage remains well below its historic level.
• The minimum wage is below its traditional level of purchasing power. Currently,
the minimum wage is 22 percent lower than its average during the 1970s, after
adjusting for inflation* If the value of the minimum wage were to have the same
purchasing power in 1993 as it averaged in the 1970s, it would need to be $5.42
an hour.
Tlie expansion enacted in 1990 was not a pure increase in assistance to the working poor. In part, the expan-
sion was designed to offset other tax provisions of the 1990 deficit reduction package (such as increased gasoline
taxes) that took a larger share of income from the poor than from the middle class or the wealthy.
To determine the inflation-adjusted value of the minimum wage in 1993, an inflation rate of 3.0 percent was
assumed for 1993. This is the most recent inflation rate projection issued by the Congressional Budget Office.
These data were adjusted using the government's inflation indicator called the CPI-U-X.
186
• In the 1960s and 1970s, full-time year-round work at the minimum wage usually
lifted a family of three above the poverty line. By contrast, in 1993, full-time year-
round minimum wage earnings will leave a family of three $2,700 - or 23 percent
- below the estimated three-person poverty line.
The minimum wage is now so low that a famOy oi three with a full-time minimum
wage worker remains below the poverty line - even when EIC benefits are added. This
is seen by comparing the combined value of full-time year-round minimum wage earn-
ings and EIC benefits, minus payroll taxes, to the poverty line.
• In 1993, full-time minimum wage earnings plus EIC benefits, minus payroll
taxes, will leave a family of three 51,850 below the poverty line. ' (Minimum
wage earnings of $8,840 plus EIC benefits of S 1,51 1 minus payroll taxes of $676
totals a net income of $9,675. This compares to the estimated three-person pov-
erty line in 1993 of $11,523.)
• Since the poverty line rises with family size, the degree to which full- time earn-
ings and EIC benefits fall short of the poverty line grows as family size increases.
Full-time minimum wage earnings plus EIC benefits, minus payroll taxes, leaves
a family of four some $5,100 below the poverty line in 1993.
If the combination of minimum wage earnings plus the Earned Income Tax Credit
is to lift families out oi poverty, these policies need strengthening. Moreover, it is im-
perative that policy reforms not rely too heavily on one policy instead of the other. The
two policies are best viewed as complementary approaches, for several reasons.
• Cost. The cost of the EIC expansion necessary to meet the goal that families with
full-time workers escape poverty is exceptionally sensitive to the value of the
minimum wage. Without some increase in the minimum wage, the cost of the
EIC expansion to the government is likely to be several billion dollars larger than
otheru'ise. The costs ot the minimum wage expansion are borne by the private,
rather than the public, sector (and by those who benefit from the goods produced
by minimum wage workers).
• Targeting. Compared to the minimum wage, the EIC is better targeted to the
working poor and the near-poor, and also can be adjusted by the number of chil-
dren in the famOy. At the same time, the minimum wage benefits poor single in-
dividuals and childless couples while the EIC does not. In addition, the minimum
wage is relevant to most of the working poor. Among poor workers, most do have
earnings at or near the minimum wage.**
• Marginal tax rates. Any expansion in the EIC would further increase the already
high marginal tax rates in the income range over which the EIC is phased down.
Even under current law, these marginal tax rates can exceed 50 percent. (That is,
for each additional dollar of earnings, more than 50 cents is lost due to taxes or
decreased benefits.) Since the minimum wage does not phase down as income
rises, a higher minimum wage does not raise marginal tax rates.
' As noted, the full effect of the 1990 EIC expansions will not be felt until tax year 1994. But under current law,
full-time minimum wage earnings will still fall $1,660 below the poverty line for a family of three in 1994 when
the EIC is added and payroll taxes are subtracted. The fall in the purchasing power of the minimum wage from
1993 to 1994 (if it remains at $4.25 an hour) nearly offsets the effect of the expansion in the EIC.
' Since the minimum wage assists all low-wage workers, whether or not they live in households with low in-
comes, it has been criticized as an inefficient mechanism for assisting the working poor. The majority of mini-
mum wage workers are not poor.
At the same time, the level of the minimum wage is important to the working poor. Data from the Congres-
sional Budget Office indicate that more than half of workers in poverty earn wages at or near the minimum
wages.?? In 1987, some 57 percent of poor workers had earnings at or near the minimum wage, earning $4.35 an
hour or less. It turns out that $4.35 an hour in 1987 matched the figure that the minimum wage was at in the
1960s and 1970s, after adjusting for inflation.
In addition, the increased earnings might also be of great use to some workers in moderate income families
who are not officially poor, whether the example may be a young worker saving for college or perhaps a family's
second earner attempting to supplement the family's squeezed standard of living.
187
• Timing of payments. More than 99 percent of EIC recipients receive the credit in
one annual lump sum payment. An advance payment system is in place that en-
ables eligible workers to receive their EIC through their regular paychecks, but
this system does not function well and will be difficult to improve. The minimum
wage delivers the income on a more timely basis; its benefits are received auto-
matically in each paycheck.
In short, the strengths of the two policies complement each other. The EIC is
better-targeted while the minimum wage delivers its benefits on a more timely basis
without raising marginal tax rates. If the EIC is relied upon too heavily, the public costs
are likely to be very high, but a combination approach results in the sharing of costs
between the public and private sectors.
While expanding the EIC has received widespread, bipartisan support in policy
circles, expansions to the minimum wage have proven more controversial.
The potential effect of a minimum wage increase on employment has been the
principal argument raised in opposition to such an increase. The argument is made that
a higher minimum wage would price a large number of workers out of the labor mar-
ket. The effects are likely to be particularly harsh for teenagers, it is argued, since such
a large proportion of young workers have earnings at the minimum wage and their jobs
are among the most marginal.
While the potential employment effects of a minimum wage increase surely need to
be considered, the weight of the empirical evidence suggests that the effects are likely
to be modest. During the 1960s and the 1970s, a series of studies examined the rela-
tionship between emplo>Tnent opportunities and the minimum wage. Economists Char-
les Brown, Curtis Gilroy, and Andrew Kohen reviewed these studies for the federal
Minimum Wage Study Commission established in the late 1970s. They also conducted
their own study, based on a reformulation and an update of the earlier work. At the
time it was issued in the early 1980s, their study was considered the most exhaustive
and thorough study of the employment effects of the minimum wage.
Brown and his colleagues found a 10 percent increase in the minimum wage to be
associated with a one percent decrease in the employment of teenagers and a one-
quarter of one percent decrease in the employment of young adults (20 to 24 year
olds). The economists found no strong evidence of any job loss for adults 25 and over.''
This study was based on labor market data from 1954 to 1979. Since then, labor
markets - especially labor markets for young workers - have changed. The study con-
ducted by Brown, Gilroy, and Kohen has been updated uath information through 1986
and refined. The update, conducted wth Brown's guidance, found a more modest ef-
fect on teenage employment - that a 10 percent increase in the minimum wage was as-
sociated with a decrease of six-tenths of one percent in teenage employment'" In
addition, the study found no significant relationship between the level of the minimum
wage and the level of employment of adults aged 20 to 24t.
Moreover, studies by some of the nation's leading labor economists of the impact
of the increases in the minimum wage in April 1990 and April 1991 have found it did
not reduce employment. David Card of Princeton University examined the effects of
the minimum wage increases on states with differing proportions of low-wage workers.
He found that the wage increases boosted incomes but did not negatively affect em-
ployment, even among teenagers. Card reported: "Comparisons of grouped and indi-
vidual state data confirm that the rise in the minimum wage increased teenagers' wages.
There is no evidence of corresponding losses in teenage employment.""
' Charles Brown, Curtis Gilroy, and Andrew Kohen, 'Time-Series Evidence of the Effects of the Minimum
Wage' on Youth Employment and Unemplo>'ment," The journal of Human Resources, Winter 1983. Many of the
estimates of large job losses made during the debate over the appropriate size of the minimum wage in the late
1980s were based on the high range of the studies from the 1960s and the 1970s, often ignoring the review and
ujxlate of these studies by Brown, Gilroy, and Kohen.
"' Alison J. Wellington, "Effect of the Minimum Wage on the Emplo>Tnent Status of Youths: An Update," The
Journal of Human Resources, Winter 1991.
" David Card, "Using Regional Variation in Wages to Measure the Effects of the Federal Minimum Wage," In-
188
Another notable study of the impact of the recent increases in the minimum wage
was conducted by Lawrence Katz and Alan Krueger. (Katz was then at Harvard Uni-
versity; he is now chief economist of the U.S. Department of Labor.
Krueger is a Professor at Princeton University.) Their findings suggest that the em-
ployment effects ot the recent minimum wage increases, if anything, seem to be posi-
tive rather than negative'^ Katz and Krueger also found that the minimum wage
increases had no effect on inflation.
These studies do not suggest or prove that any increase in the minimum wage - no
matter how large - would have only desirable effects. But the outcomes of the studies
suggest that the labor market functions in a more complicated manner than has been
assumed by those who have contended that virtually any rise in the minimum wage re-
sults in a significant decrease in employment levels. In particular, when the minimum
wage is at especially low levels, as it is today, the employment effects of a change in the
minimum wage may be modest.
Designing EIC And Minimum Wage Expansions
To strengthen the EIC, one necessary step is to establish a third EIC tier for fami-
lies with three or more children" Family needs increase with family size. The poverty
line and welfare benefits do as well. But wages do not. As a result, as the number of
children in a low-wage family grows, the family falls steadily further below the poverty
line - and wages become increasingly less competitive with welfare.
The implications are far-reaching. Poverty rates are much higher among larger
families than smaller ones. In addition. Census data show that 60 percent of all chil-
dren in working poor families live in families with three or more children.
The EIC now has two tiers - a basic benefit for a family with one child and a bene-
fit about $160 a year higher for a family with two or more children.''' The $160 annual
increment is far smaller than the increase in the poverty line or in welfare benefits for
an additional child.
A restructured EIC could include a third tier of benefits for families with three or
more children. Such a proposal has received broad support from across the political
spectrum. In 1991, for example, the bipartisan National Commission on Children
unanimously recommended the addition of a third tier to the EIC. Other proposals
have gone even farther. In 1988, Representative Thomas Petri (R- Wisconsin) pro-
posed an EIC expansion that would have created four tiers, including one for families
with four or more children.
In considering expansions to the minimum wage, decisions need to be made about
both the level at which to set the minimum wage and how fast to get there. If the deci-
sion is made that the minimum wage should be significantly higher than the current
level, it may be appropriate to reach that level through a series of steps over several
years. Too large a one-time jump could be difficult for labor markets to absorb. The
first increase should also be moderate enough that it does not interfere with a still weak
economic recovery.
A second issue arises regardless of the level selected for the minimum wage - once
the level is reached, should the minimum wage be indexed (that is, should it be ad-
justed each year in accordance with the inflation rate or with the rate of growth in the
dustrial & Labor Relations Review, October 1992.
'' Lawrence Katz and Alan Krueger, "The Effect of the Minimum Wage on the Fast-Food Industry," Industrial &
Lahor Relations Review, October 1992.
" In part, expansions to the EIC can be paid for by restructuring the credit itself For example, the scheduled
expansion in the credit for families with one child from 1993 to 1994 could be scaled back. This would improve
the targeting of the credit. In addition, an EIC expansion could be coupled vAth the elimination of the two sup-
plemental credits now part of the EIC - an extra credit provided to families with a child under age one and a
credit given to families that incur premium costs for a health insurance policy that covers a child. Neither of
these two supplemental credits represents sound policy. Their elimination would save a litde more than $1 billion
a year and would greatly improve the simplicity of the EIC.
" The gap of $160 applies to 1994, which is when the EIC expansion will be fully implemented.
189
wages of the average worker in the economy)? Indexing the minimum wage allows for
small, steady changes in the minimum wage that labor markets should be able to ab-
sorb. If the minimum wage is not indexed, the EIC will have to be expanded further
every year - to compensate for the loss in the purchasing power of the minimum wage -
if the goal that families with full-time workers should not be poor is to be met.
President Clinton has endorsed indexing the value of the minimum wage. In addi-
tion, a very recent Wall Street Journal article reported that "Labor Department officials
are expected to push for an increase of as much as 10% in the minimum wage, which is
currently $4.25 [an hour], and then index it to inflation."" The article then went on to
describe how business groups are gearing up to oppose this presumably large increase
in »^^he minimum wage.
The article did not include any context in which to judge the resulting value of the
minimum wage. It turns out that an increase in the minimum wage of 10 percent would
simply return its value to that achieved on April 1, 1991, when the minimum wage was
last raised. This was the value agreed to by President Bush; he vetoed a bill requiring a
higher level. More importantly, even with the 10 percent increase, the minimum wage
would remain well below its traditional level of support, after adjusting for inflation. Its
purchasing power would remain 16 percent below its average during the 1970s.
In any given year, increasing the minimum wage by more than 10 percent would
probably be too much of a shock to the labor market. But if the minimum wage is to be
restored to a level closer to its historic value, and in order to get closer to the goal that
all families with full-time workers should not be poor, a real increase of more than 10
percent - spread out over several years - is appropriate.
A Fine Opportunity
The next few years could bode well for "make work pay" initiatives. President Clin-
ton supports the goal that families with full-time workers should not be poor, and he is
not alone in this.
Across the political spectrum, and among politicians and analysts alike, there is
broad support for this principle. Some of the specific proposals receive widespread ac-
claim as well, such as expanding the Earned Income Tax Credit. Even policies such as
strengthening the minimum wage, while contentious within policy circles, receive broad
support from the general public. In the late 1980s, polls showed that a large majority of
Republicans, Democrats, and Independents alike favored a minimum wage increase.'*'
The opportunity to accomplish a substantial part of the unfinished agenda for the
working poor is at hand. Such an accomplishment is a necessary complement to
strengthening policies that invest in our nation's current and future workers.
" Kevin G. Salwen, "Business Groups Prepare to Square Off Against Clinton on Minimum Wage Issue," Wall
Street journal, February 8, p. A2.
" George Gallup, Jr. and Alec Gallup, 'Proposal to Boost Minimum Wage has Overwhelming Public Suppwrt,"
June 19, 1988. The poll asked "do you favor or oppose increasing the minimum wage [from $3.35 per hour] to
$5.05 per hour over the next four years?" Some 67 percent of Republicans, 85 percent of Democrats, and 74 per-
cent of Independents responded favorably to this question.
190
Fully Funding WIC Would be a Good Investment
and Would Contribute to Economic Stimulus as Well
The focus of this testimony is on the EIC and the minimum wage, but I
would also like to discuss a policy area that the Center on Budget and Policy Pri-
orities has focused on intently, and that is the Special Supplemental Food Pro-
gram for Woemn, Infants, and Children. WIC provides nutritious foods,
nutrition assessment and counseling, and health care referrals to low-income
pregnant and postpartum women, infants, and children under the age of five who
are determined to be at nutritional risk.
The General Accounting Office recently stsudies an array of children's pro-
grams and concluded that the WIC had the best documental return on investment of
any federal early intervention program. The GAO concluded that each dollar in-
vested in prenatal WIC benefits saves $2.89 in Medicaid, SSI, special education,
and other health care costs wthin the first year afater birth — and saves S3. 50
over 18 years.
Similarly, a study conducted for USDA by Mathematica Policy Research and
issued in 1991 estimated that each dollar invested in prenatal WIC benefits saves
between $1.92 and $4.21 in Medicaid costs during the first months after birth.
The payoff for WIC fimding is a main reason why the program receives
strong support among key business leaders. In March 1991, the CEOs of AT&T,
BeOSouth, Hone^'weO and Prudential testified on WIC before a hearing of the
House Budget Committee that was convened solely to hear their testimony.
They caUed for fiilly funding WIC by FY 1996.
There is broad bipartisan support for this goal. Last summer, for example,
87 Senators signed a letter calling for funding WIC at the level appropriate to
reach full funding by FY 1996. The tu'o Budget Committees have also embraced
this goal when designing their budget resolutions. President Clinton has en-
dorsed full funding of WIC as well, but has yet to specify when this goal should
be achieved.
Expediting the fully funding of WIC merits consideration in the economic
stimulus package. The best human capital programs for inclusion in a stimulus
package are those that : l)have a high spend-out rate (so they will put money
into the economy quickly, increasing aggregate demand); and (2) are successful
programs that represent the types of long-term investments the nation needs any-
way. Thus, programs with high spend-out rates that are already part of long-term
investment plans are excellent candidates for the stimulus package. The desired
long-term expansion of these programs can simply be front-loaded, at no addi-
tional long-ter cost.
WIC fits this bill well. Its spend-out rate is 93 percent in the first year. Full
funding of WIC also is onthe long-term agenda of the Administration and much
of Congress.
191
PREPARED STATEMENT OF RICHARD VEDDER
JOBS AND PUBUC POUCY
For most people, the quality of economic life is determined by the type of their job.
Most income in America is generated from work, and most inequality in economic con-
dition is traceable to differences in earnings capacity and performance between indi-
viduals. Good public policy, then, obviously must promote the development of
employment opportunities both quantitatively and qualitatively.
What can be done to reduce unemployment? I am an economic historian who,
along with my colleague Lowell Gallaway, have written a book. Out of Work: Unem-
ployment and Government in Twentieth-Century America, that has just been published
by Holmes and Meier of New York for the Oakland based Independent Institute. Our
examination of 90 years of American employment history suggests that jobs are created
quantitatively in greater amounts when market forces are allowed to operate unthout
substantial government interference. Moreover, the greatest periods of high unemploy-
ment in American history are largely attributable to well intentioned interventions in
the labor market that led to wages for workers being pushed above an equilibrium level
consistent with full employment.
A Brief Employment History Of Twentieth-Century America
In our book Out of Work. Lowell Gallaway and I argue that unemployment rates
are closely correlated with what we call the adjusted real wage, which is money wages
adjusted both for changes in prices and productivity per worker. Figure 1 shows the
actual unemployment rate by year and what our statistical model based on the adjusted
real wage and its wage, price and productivity' components predicts the unemployment
rate to be. The model explains about 90 percent of the considerable variation in unem-
ployment rates in the twentieth century.
The lowest unemployment rates in the 20th century occurred during the period
1900-1929, a period when federal intervention in labor markets was at a low level. The
single incident of double digit unemployment, the Depression of 1921, was probably
caused by the effects of rapid inflation followed by unexpectedly severe deflation. Both
price movements were aided by the newly established Federal Reserve System. The
Fed's failure to stabilize prices contributed importantly to the severity of the 1921
downturn. Money wages lagged behind changes in prices, and for a time real wages
rose, pricing labor out of the market, and causing the downturn. We got out of the de-
pression uathin two years without any federal intervention; the president, Woodrow
Wilson, was immobilized with health problems and the new president, Warren
Harding, was disinclined to do anything about the problem. The market solved the
problems through wage adjustments and productivity advances.
The Great Depression can be explained in terms of Herbert Hoover's high wage
policy, which priced labor out of the market and, additionally, contributed to the bank-
ing crisis by lowering the value of bank loans to businesses, loans that lost value as
firms became financially vulnerable from paying workers above normal wages. The
Smoot-Hawley tariff reduced international labor competition, contributing to higher
wages and the resultant higher unemployment.
Franklin Roosevelt continued the high wage policy, as such policies as the National
Industrial Recovery Act and the National Labor Relations Act contributed to wage ex-
plosions that prevented market adjustments from working normally.
The powers of labor market adjustment were best shown after World War II. In 12
months, the federal government reduced its employment by 10,000,000 - the equiva-
lent today, in relation to the labor force, of 22 million. At the same time, the govern-
ment went from running a deficit that was the equivalent today of over one trillion
dollars to running a substantial budget surplus. The Keynesian economists of the era
predicted massive unemployment. In reality, the annual unemployment rate never
reached four percent. Markets handled the adjustment from war to peace beautifully,
without special job training programs, federal infrastructure spending or the like.
192
The low unemployment prosperity of the late 1940s and 1950s occurred despite
rather conservative monetary and fiscal policies of Presidents Truman and Eisenhower.
Per capita federal public debt fell under both presidents. Federal labor market inter-
vention actually decreased in some respects, notably with the passage of the Taft-
Hardey Act. Yet unemployment never reached as high as it is today.
The 1960s prosperity was real, but the seeds of the 1970s economic malaise were
sowed in that decade. One very positive development was the Kennedy tax cut, which
had an important positive impact on the aggregate supply of goods and services. The
following of a deliberately inflationary fiscal policy during the Kennedy, Johnson and
Nixon administrations, however, led to a rise in inflationary expectations and a resul-
tant decline in the effectiveness of countercyclical macropolicy. The attempt to reduce
the adjusted real wage through deliberate inflation worked in the 1960s, but not in the
1970s, as people caught on and demanded and got bigger wage increases; lenders simi-
larly demanded and got higher interest rates. As usual, Abraham Lincoln was right: you
can fool all the people some of the time, some of the people all the time, but you can-
not fool all the people all the time. The "money iOusion" that explains the Phillips curve
relationship came to an end as workers could no longer be fooled.
The 1982 recession was an inevitable effect of the totally unanticipated disinflation
of 1981-82. For a time, money wages rose faster than prices, pushing up real wages and
pricing workers out of the market. Within a year, however, without any particular inter-
vention by the federal government, the economy turned around, with millions of new
jobs formed in 1983 and 1984.
The great jobs explosion of the 1980s can be attributed in large part to moderation
in wage growth and some pickup in labor productivity from the anemic experience of
the 1970s. The decline in the importance of labor unions and the failure to increase the
federal minimum wage for nine years are just two factors that contributed to this mod-
eration; increasing international product and labor market competition is probably a
third factor.
The 1990 recession followed a wage explosion at the beginning of 1990. Compen-
sation per hour rose at an annual rate of eight percent in the second quarter of that
year, reflecting in large part the minimum wage increase that took effect on April 1. A
second minimum wage increase the following year contributed to continued upward
labor cost pressures that made it difficult to get the normal market adjustments to end
the downturn.
Labor Markets And The Current Economic Situation
Labor will be hired when the price is right. Like virtually anything else, more labor
is hired when it becomes cheaper - the Law of Demand works in labor markets as it
works in the potato market. Any government effort that tends to increase the cost of
labor will tend to reduce job opportunities for American citizens.
For the past several months, the adjusted real wage has been falling. Moderate
wage settlements combined with rising labor productivity have reduced labor costs per
dollar of sales, which is beginning to lead to greater demand for workers. Since June,
the unemployment rate has faUen at least one-fourth of the way back to its long run
sustainable rate, and my reading of the statistics on wages, prices and productivity leads
me to believe the unemployment rate uill be down to 6.5 percent by this summer,
without any intervention. Thus, without any special government policy, unemployment
will have fallen in about a year at least half way back to normal from its recession high.
Proposed Clinton Economic Policies
I am somewhat concerned, however, that the recovery could be disturbed by well
intentioned policies that tend to raise labor costs and thus lead to reductions in employ-
ment. Labor Secretary Reich, for example, is on record for favoring increases in the
minimum wage, including tying it to changing wages in the economy. The sharp in-
crease in the minimum wage in 1990 and 1991 contributed importantly to the rise in
the adjusted real wage at that time that brought about the 1990 recession. The tragedy
of minimum wage intervention is that the burden of unemployment that is generated
193
falls largely on the young, the unskilled, and members of minority groups. The burden
falls on those least able to afford it.
Other proposals discussed during the campaign or since would have similar nega-
tive effects. Banning the hiring of replacement workers in strike situations reinforces
wage rigidities that collective bargaining agreements impose, rigidities that tend to pre-
vent markets from alleviating joblessness. A training tax to finance worker training like-
wise would increase labor costs per dollar of sales, leading employers to reduce hiring.
Extending unemployment insurance benefits further, already at a historic high with re-
spect to duration, would raise what economists call the reservation wage, reducing job
growth in months ahead. Similarly, proposed increases in taxes on income would re-
duce the quantity of labor supplied. It is no accident that the creation of five thousand
jobs a day during the 1980s occurred at a time that changes in the tax code increased
the spirit of enterprise and the work efforts of Americans. A similar job boom followed
the enactment of John F. Kennedy's tax cut in the 1960s.
The new Family Leave act will increase labor costs somewhat which will have nega-
tive employment effects unless offset by reductions in wages and/or benefit levels. Such
adjustments no doubt will occur in the long run. Indications that the Clinton admini-
stration will be amenable to higher tariffs is a bad sign. Economists are virtually unani-
mous in believing that the Smoot-Hawley tariff contributed to the Great Depression,
and higher duties will tend to inflate wage settlements in protected industries, just as it
did after 1930.
Most jobs are generated by small business, and the boom of jobs in the mid-1980s
can be attributed in part to a favorable regulatory environment towards small business,
while the sluggish job growth during the past several years can be at least partially ex-
plained by increased per worker burden associated uath public policy. The Clinton ad-
ministration would be well served to reverse the anti-small business bias of the Bush
years, returning to the environment of the Reagan era which provided a regulatory and
tax setting conducive to the hiring of labor.
It has been brought to my attention that members of the minority staff of this
Committee have quantified the burden on small business of various federal tax and
regulatory policies. Figure 2 shows the time trend in this burden. Note the sharp rise in
the burden after George Bush took office. I do not think it is coincidental that job
growth began slowing very shortly after these federally imposed costs began rising.
In the long run, the twin goals of high living standards and substantial job opportu-
nities for American workers are incompatible objectives, unless the productivity of la-
bor rises. High wages price workers out of markets, so getting rising wages and more
employment requires output per worker to rise. President Clinton seems aware of this
imperative.
Two planks of the Clinton economic program likely will be infrastructure construc-
tion and job training programs. Infrastructure investments should be made based on
their expected rate of return to society. History suggests that public works programs to
augment employment simply are not effective. Five years into the New Deal, and eight
years into the Great Depression, massive public works expenditures had left the nation
with an unemployment rate approaching 20 percent, vinth the modest improvement
from the Depression trough being explainable by productivity growth in the private
sector. Federal spending crowds out private sector spending, and there is some evi-
dence that a shift of resources to public uses causes a drag on labor productivity. That
aside, public works projects take a long time to implement, at least a year, and by the
time infrastructure spending comes on line, the unemployment problem will be elimi-
nated. Finally, how can a nation be serious about deficit reduction if it is introducing
new spending programs?
Regarding job training, the evidence with respect to federal job training programs is
not particularly reassuring. More important, however, there is decisive evidence that
the most important variable in improving labor productivity is work experience. Male
high school graduates who were year round full-time workers averaged $16,559 a year
work income in 1990 if they were 18 to 24 years old, but $32,336 a year if they were 45
194
to 49 years old. Assuming workers are roughly paid according to productivity, the more
experienced workers seem to be roughly twice as productive as the relatively inexperi-
enced ones. For college graduates, the earnings growth associated with experience is
still larger. The earnings gains for women tend to be somewhat less, but are still sub-
stantial.
Assuming compensation is determined by productivity considerations, the earnings
data by age suggest that labor productivity for a typical male high school graduate rises
by roughly three percent a year from the time the person takes his first job to the time
that productivity nears a peak when the worker is in his mid-forties. Because the work
experience of females is more likely to be interrupted, it is more difficult from the ag-
gregate data to estimate the productivity growth for women, but I suspect that it proba-
bly very closely approaches that for men. The data suggest that a large proportion of
the earnings gains associated with work arise from the experiences derived on the job.
On the job training can be best promoted by simply getting people to work. The incen-
tive structure is there to lead workers to want to improve their economic condition by
learning on the job.
Earnings data suggest that the second great contributor to productivity advances
may be education. I say "may", because employers may pay college graduates a lot more
than high school graduates not simply because of the added knowledge acquired, but
because college graduates tend to be smarter, more motivated, more mature, and so
on. Education may be largely a screening device to find the more able members of the
population. Nonetheless, to the affected individuals education has a payoff, indeed one
that has grown over time.
Yet the evidence is equally clear that spending more money on public education
does not lead to greater learning. Eric Hanushek of the University of Rochester has
surveyed the literature on several occasions, always concluding that a majority of stud-
ies show little or no relationship between the amount of resources expended on public
education and the amount learned. My own research with colleagues reinforces the Ha-
nushek conclusion: spending on direct instruction can modestly impact on learning, but
a very large proportion of school budgets go for non-instructional purposes that are
unrelated or even negatively relative to learning.
The work of James Coleman showing the relative success of parochial schools, with
much lower spending per pupil, reinforces Hanushek's conclusion. In short, even if you
determine that there is a high potential productivity payoff to education and training,
there is little evidence that, with current systems of educational delivery, spending more
on the problem makes much difference. What does seem to make a difference, as
Brookings Institution researcher John Chubb and Stanford Professor Terry Moe have
observed, is the way schools are organized. Also critical is the sense of school commu-
nity that is developed and the family environment. Kids from intact two parent homes
learn more than those from single parent situations. Pouring more money into educa-
tion without other reforms would be a tragic misuse of public resources.
Public Policies Creating Unemployment: The Tragedy Of Minorities
Yet public policy has failed miserably in getting persons to take that critical first job
and stick with it. This is particularly true of the disadvantaged and racial minorities. As
Figure 3 shows, in the year of Brown vs. Board of Education, at the beginning of the
civil rights movement, 58 percent of nonwhite Americans of working age had jobs. In
1992, the proportion was less, under 56 percent. By contrast, for whites, the proportion
working Increased dramatically over time, from about 55 to 62 percent. In 1954, non-
whites outworked whites, while today the reverse is true. This is so despite a myriad of
civil rights laws designed to reduce racial discrimination.
Why has this happened? I would argue that federal programs designed to help low
income Americans disproportionately affect minorities. These programs have reduced
work effort among the poor relative to the non-poor. The true marginal tax rate on
work income for black Americans is probably on average much higher than that for
whites, simply because of the insidious effects of public assistance programs. A young
black teenage girl with a baby considering taking welfare or a $6 an hour job will
195
usually take welfare, since the welfare benefit package is worth as much as the work
income. There is, effectively, a 100 percent tax on work. The white male graduating
from college in engineering, however, will take a $30,000 job over the $12,000 welfare
alternative. Our public policies discourage work effort among the minorities, prevent-
ing them from taking the first step up the job training ladder towards more productive
employment.
Thus public policy has robbed the nation of productive resources; we have pre-
vented some of our citizens from taking low paying jobs that lead to the experience and
productivity gains that ultimately result in more remunerative employment. Median
black family income has declined relative to white income since 1967, despite narrow-
ing pay differentials in comparable employment, simply because of declining black la-
bor force participation resulting from public policy.
A Final Word
In short, public policy has deterred productivity growth, has promoted unemploy-
ment, and has been regressive in the most fundamental meaning of that word. Instead
of re-creating old programs that have failed in the past, I hope the Clinton Administra-
tion looks to new market-based solutions to our problem of unemployment and inade-
quate productivity growth. Thank you.
BOSTON PUBLIC LIBRARY
196
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FIGURE 2
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