The U.S. Economy In an Election Year

 

Murray Weidenbaum

      Murray Weidenbaum holds the Mallinckrodt Distinguished University Professorship at Washington University, where he is also honorary chairman of the Weidenbaum Center on the Economy, Government, and Public Policy. This article is an address given to the Missouri CPA Educational Foundation in St. Louis, MO, March 26, 2004.

      It is a real pleasure to have the opportunity to start off a presentation on the U.S. economy with an upbeat message. Virtually every professional forecaster is now in agreement on the meaning of the economic tea leaves or entrails or whatever divining device they use: The economic outlook is very positive. U.S. gross domestic product (GDP) will rise by more than 4 percent in 2004, and maybe even closer to 5 percent.

      Although crystal balls get a bit foggier when we try to go beyond the year, the widespread expectation is that economic growth in 2005 will also be substantial, although a bit more modest. The prevailing projection is now in the healthy range of 3-4 percent. To put the matter bluntly, that is not bad at all.

      Simultaneously, inflation is likely to stay low, in the neighborhood of 2 percent. Yes, oil and commodity prices are rising significantly. However, most of that potential inflationary pressure will be offset by continued softness in industrial prices. That is the positive side of the tough competition from low-cost Asian factories, especially in China.

      Given this generally positive view of the economic outlook, we have to worry about the response to all this by the folks at the Federal Reserve System. Will they see the stirrings of inflation on the horizon and begin to raise interest rates? If so, when? In the past, a series of interest rate increases by the Fed has cooled down and occasionally stopped a rapidly rising economy. This time around, I believe that the slow growth in employment is causing the Fed to hesitate and literally to mark time. Unless the outlook changes substantially, they may not start raising rates until the new year. The Fed certainly does not want to get caught in the crossfire of an election year campaign—and this presidential campaign has started very early.

      What about those huge budget deficits? First of all, they are huge. Several hundreds of billions of dollars of red ink in one year is nothing to cheer or even to ignore. Brushing aside the political aspects, however, we have to make a basic distinction. No, I do not mean between Democratic and Republican deficits. Such a partisan approach would not be very helpful. My distinction is between the short run and the long run.

      In the short run—this year and next—large budget deficits are providing useful stimulus to the economy with critical slack in manufacturing and labor resources. Under these circumstances, the deficits are not generating any serious inflationary pressures. That does not mean that every tax cut is optimum or that each spending increase is exactly meritorious. The real concern is in the years ahead—in the longer run when the Medicare Trust Fund starts running low and later when the Social Security Fund begins to run down. I’ll get back to all that a little later.

      To put the economic outlook in a nutshell, the American economy is growing faster than any other major industrial economy on the globe. That does not mean that we do not face any serious problems. Nevertheless, it is useful to start with a realistically positive appraisal. You do not have to endorse every action by the Administration or the Congress or the Federal Reserve to note that the recession is long since over. For most Americans, the economic situation is improving.

The Job Situation

      Having gotten that off my chest, let me now turn to the serious economic challenges that do face the United States. The first is jobs. The fact is that, however you measure it, the generation of new jobs in the last few years is slower than in most recent recoveries. Of course, the recession was one of the mildest in decades, so the recovery has also been relatively mild and slow getting up steam.

      As you may know, the government uses two different methods of measuring employment in the United States. Neither of these statistical approaches is perfect. Trying to achieve perfection would cost too much. The first measure is to take a sample of households. That is useful because it picks up the self-employed and people who just started new businesses. This household survey is especially valuable because it is the basis for determining the unemployment rate, which is now 5.6 percent. That is down from the average of 6.0 percent last year. These household data also show that 1.7 million new jobs have been created since 2000. However, the statistical results may not be too exact because the government samples only a small number of households.

      Most labor market analysts prefer the much larger survey of business establishments. This second survey gives us detail by industry as well as data on earnings and hours worked. This series reports a reduction of 1.6 million jobs since 2000. That consists of a 2.9 million drop in manufacturing employment, offset in part by rises in government and service payrolls. Neither measure of employment is cause for celebration. The establishment survey surely is not good news, nor is the sluggish rise in job creation reported by the household survey.

      In this election year particularly, there is a search for culprits. The easiest choice seems to be overseas. If you believe some of the scary headlines or TV broadcasts, most American jobs are moving overseas or are under that imminent threat. That is sheer nonsense. I will get to the pluses and minuses of outsourcing in a moment, but first I have to point out some basic economic facts.

      First of all, American manufacturing companies are producing more at home albeit often with fewer workers. The reason is not anything happening overseas. The obvious answer is the right one: American workers are increasingly more productive. That should not be surprising. Business investment in new technology and in new factories and production equipment is on the rise. So is the education and training of the American work force.

      Let us not overlook the positive power of enhancing productivity. That is the basis for the rise in real wages. Average weekly earnings have increased from $480 in 2000 to $522 today. In constant dollars, the rise is 1.3 percent. The other fundamental reason for welcoming the growth of productivity is that it is essential in keeping prices low and thus maintaining living standards at home and U.S. competitiveness in an increasingly global marketplace.

Some Facts on Outsourcing

      Now what about outsourcing? Unfortunately, it takes more than a bumper sticker to provide a serious response. For starters, I wince every time I hear a politician referring to American companies that outsource overseas as Benedict Arnolds. That is worse than a cheap shot. It is just plain wrong and for several reasons. It ignores all of the Lafayette companies, Pulaski companies, and von Steuben companies, to cite a few foreigners who came over here to help us fight for independence. I am really referring, of course, to the many foreign corporations that regularly outsource jobs to the United States. For example, much of the growth of automobile production in the United States in recent years has been due to those “transplants” from overseas. To be even-handed, the opponents of outsourcing should object to the export of Hondas to Japan from the company’s factory in Marysville, Ohio. Don’t they also worry about “fairness” to the Japanese workers? It is difficult to find any consistent logic in the criticism of outsourcing.

      As for the export of call center and other service jobs, we cannot ignore the fact that far more service jobs are created in the United States to meet the needs of foreign companies. The data on services are compelling. In 2003, American service providers “insourced” $130 billion from abroad. They outsourced $76 billion overseas. The net plus in our balance of trade was $54 billion. It is sad that so few who write about outsourcing even bother to look up the basic data.

      Do those who advocate laws against our outsourcing overseas really believe that foreign governments will not retaliate? My guess is that they never even thought about the fact that companies all over the world are outsourcing. Surely they have not bothered to find out that the United States has such a large stake in open markets—at home and abroad. We are both the world’s largest importer and the world’s largest exporter.

      Actually, outsourcing is part of a far more basic trend: companies increasingly focus on their core competence. They enhance their competitiveness by contracting out work that can be done more efficiently by other companies. Most of these moves to greater specialization of labor result in domestic outsourcing. In fact, a portion of the reported decline in manufacturing employment—and also a part of the rise in service employment—is a statistical artifact. Those offsetting changes result from industrial companies contracting out overhead functions. Converting an activity from an overhead burden center in a manufacturing company to a profit center in a service firm is a prod to achieving greater efficiency. The resultant reduction in cost to the industrial corporation is an important part of the necessary efforts to maintain its competitiveness.

Tax Cuts and Budget Deficits

      Let us turn to another controversial area of economic policy—tax cuts and budget deficits. You do not have to agree with the size or composition of the tax cuts to be upset by the deterioration of economic discourse on this important subject. Are the tax cuts really a giveaway to the rich? In answering this loaded question, I find it useful to start with an examination of the factual data supplied by the Internal Revenue Service.

      When analysts array taxpayers according to their reported income, IRS data show that the top half of taxpayers pay about 90 percent of the personal income tax and the bottom half about 10 percent. Under the circumstances, I do not find it surprising that most of the recent tax cuts went to the 90 percent. I do not happen to agree with some aspects of the recent tax legislation. Nevertheless, I do not see anything wrong with tax cuts going to those who pay the taxes. Rather, it strikes me as eminently fair.

      By the way, one of the best-kept secrets in Washington, DC—which is normally described as a sieve—is that the federal income tax is progressive. Let us look at 2000, the latest year for which I could obtain data. In 2000, the average tax burden on the top 20 percent of taxpayers was 28 percent. Each successive group of taxpayers paid a smaller percentage. The bottom 20 percent paid only 6 percent of their income as federal income tax. The results seem to be quite fair: the “rich” pay more income taxes because they earn more.

      As for the budget deficits, the economist in me is bothered more by the composition than the absolute size of the red ink totals. For example, the recently enacted budget set a new high in the number and cost of congressional “add ons” of pet projects for individual states and congressional districts. Ironically, those billions of dollars added to the budget resulted from an unfortunate display of bipartisanship. It was based on high political principle of long standing—“You scratch my back and I’ll scratch yours.” When some of those big spenders turn around and complain about the budget deficits, it is hard to take them seriously.

      What is serious is the longer term trend in the federal finances. The two largest federal trust funds—the ones for Social Security and Medicare—are far from being in long-term balance. Every serious study shows that, as the baby boomers retire, those two trust funds will move from their present surpluses to unsustainable massive deficits. Something will have to give—some form of revenue increases or modifications of benefit schedules or both. That task will be difficult in any event. It would be more manageable if the rest of the budget were closer to balance or, better yet, in surplus. Unfortunately, that is not likely to be the national fiscal condition under the continuation of current circumstances.

International Issues

      Some observers believe that this is too sanguine a view of federal fiscal policy, especially in the short run. They expect that the continuation of huge budget deficits will soon put unbearable strain on the dollar. Eventually, they could be right. But so far, Americans have been enjoying a relatively benign circle of effects. Foreigners—especially Asian nations such as China and Japan—have been buying Treasury issues in large amounts. This helps finance our budget deficits with minimum impact on our modest supply of domestic saving available to finance domestic investment.

      Apparently, the two Asian giants are content to support the dollar by buying our low-yielding Treasuries. I believe that they do so for good reason. They know that the money goes to finance a stimulating economic policy. That stimulation helps to generate a growing economy that, in part, results in substantial imports from China and Japan. All this reflects our dual domestic shortcomings: Americans invest at home more than we save and we consume more than we produce. That domestic situation also is reason for our not leaning too hard on those countries who export to us so much more than they import from us. Those dollars do come back to us. The overall result is a delicate balance that benefits the countries on both sides of the Pacific Ocean. Of course, if we had a tax system that did more to encourage people to save—but that’s a subject for another day.

The Political Crossfire

      It may be an understatement to say that an election campaign is not exactly a vehicle for improving economic understanding. In that vein, some words of warning are in order. The party in power has an obvious stake in claiming the success of its programs and in heralding the strength of the economy. Similarly, the party seeking to oust them focuses on the weakness of the economy and the shortcomings in the Administration’s program. It is ever thus, no matter which party is in power. Therefore, we need to discount heavily the partisan statements that will be emanating with rising intensity and frequency from both political parties and their allies.

      It is not just a matter of their gilding the lily or fudging the facts. My concern is about the basic focus of the oncoming debates. I am sadly reminded of the 1960 presidential election where a major issue was the status of Quemoy and Matsu. Quemoy and Matsu? To those who do not recall political trivia of the 1960s, those are two barren and virtually uninhabited islands located in the Taiwan Straits. When that election was over, the two islands returned to their well-earned obscurity. We should not be surprised if the economic equivalent becomes an equally ephemeral but highly visible policy issue in the 2004 presidential campaign.

The Economic Outlook

      In any event, there is an agenda of unfinished economic business that is likely to face whoever sits in the Oval Office on January 21, 2005. That agenda should include an energy policy that effectively curtails our demand for oil imports; an education policy that helps more young people graduate high school and obtain skills necessary for productive employment; and a more financially sustainable high quality health care system.

      Meanwhile, let us enjoy the economy of 2004. It is likely to be the best for some time.     Ω

“History repeats itself. The fact is a testimony to human stupidity. The saying has become a truism; nevertheless, the study of the past is relegated to the scholar and the school-boy. And yet it is really a chart for our guidance—no less than that. Where we now are going astray and losing ourselves, other men once did the same, and they left a record of the blind alleys they went down. We are like youth that can never learn from age—but youth is young, and wisdom is for the mature.” —Edith Hamilton, U.S. Educator and Classical Scholar, 1867-1963. Quote from The Roman Way, p. 211.