John Maynard Keynes once wrote that "practical men, who believe
themselves to be quite exempt from any intellectual influences, are usually
the slaves of some defunct economist." That's exactly the situation
among today's economic policy makers: As the New Economy continues to
displace the Industrial Age economy, our policies are still rooted in
that earlier age. While the Clinton Administration took significant steps
to move its policy framework into the new era, much remains to be done.
That's why the new administration should jettison the holdover prescriptions
of Keynesian and supply-side economics, with their overriding focus on
the business cycle. Instead, the White House should embrace growth economics
focused on boosting productivity and wage growth through investment in
knowledge, support for competition and innovation, and fiscal discipline.
By raising national productivity by only one-half to one percent, the
new president can help generate significant improvements over time in
the living standards of all Americans.
The foundations of our economic policy system were laid in the 1940s,
when that period's own "New Economy" was also emerging. Memories
of the Great Depression and the fear of another depression following the
conversion from a wartime economy, coupled with the insights of Keynes,
led to the passage of the Employment Act of 1946. The Act stated that
it was the "continuing policy and responsibility of the Federal Government
to use all practicable means ... to promote maximum employment, production,
and purchasing power." The goal of the legislation, and indeed the
central organizing principle of U.S. economic policy to this day, has
been not to boost long-term growth of the economy, but rather to make
sure that recessions don't cause our economic performance to slip below
some natural, immutable rate of growth. (In the last two decades the goal
of keeping inflation low has been added as well.) When the Act spoke of
maximizing production it meant avoiding recessions, running factories
at full capacity, and getting to full employment. Government would do
this through demand management -- controlling the money supply and federal
spending and taxing to boost or restrict consumer spending and company
investment depending upon the phase of the business cycle.
The Act was silent on productivity -- the key to income growth -- in part
because economists knew little about productivity and even less about
how to boost it. It's only in the last decade that mainstream economics,
led by Stanford economist Paul Romer, has begun to focus on why income
growth occurs, focusing in particular on the key role of knowledge.
By the 1970s, conservatives and liberals shared President Richard Nixon's
view that "we are all Keynesians now." However, the emergence
of high unemployment with high inflation -- a phenomenon that was not supposed
to be possible under the old Keynesian model -- coupled with a dramatic
slowdown in productivity growth soon led many to question the prevailing
economic doctrine.
In particular, conservatives, inspired by Jude Wanniski's The Way the
World Works, attacked Keynesian "demand-side" economic policy.
The new supply-side doctrine postulated that the real issue was that high
taxes reduced incentives for companies and individuals to invest capital
and for workers, particularly high earners, to work more hours. As a result,
they argued that sizable tax cuts, particularly for upper-income Americans
and businesses, combined with regulatory relief, would stimulate investment
and job growth.
Because supply-side economics was a reaction against the old system,
not a development designed to meet the realities of the New Economy, it
did not produce the results its advocates promised. Conservatives argue
that the current economic boom actually began during the Reagan Administration.
Yet while it's true that jobs grew then, the growth was largely the result
of an unprecedented entry into the labor force of baby boom workers and
women. The real measure of success -- productivity and wage growth -- slowed
to a 100-year low.
As a doctrine, supply-side economics failed. It failed because supply-siders
were looking at old economy factors -- capital and labor supply -- and not
at New Economy factors of capital and labor quality. These are determined
by knowledge, technological innovation, and competition, as well as by
education and training. Moreover, even if one were to grant that the supply
of capital and labor is the key, it was never clear why reductions in
personal tax rates, for example, would stimulate companies to develop
or adopt technologies leading to higher productivity.
As the Progressive Policy Institute has articulated in its New Economy
Index, the New Economy is more global, more knowledge-driven, more entrepreneurial
and dynamic, and driven by digital technologies. In this New Economy,
neither Keynesianism nor supply-side economics provide the right answers
because today's economy is fundamentally different than the one of even
15 years ago. The Clinton Administration moved toward a new conception
of economic policy. It's time to build upon that and fully embrace growth
economics.
This means placing the focus of economic policy squarely on boosting
per-capita incomes, and that means focusing on productivity. As Paul Romer
states, "the most important economic policy question facing the advanced
countries of the world is how to increase the trend rate of growth of
output per capita."
It may seem obvious that productivity growth should be the object of
our economic policies, but strikingly, both liberal and conservative economic
doctrines want to take a shortcut to growth, focusing not on productivity
but on redistribution. Conservatives want to raise after-tax income by
cutting taxes -- taking from public expenditures to boost private incomes.
Liberals want to tax the rich more, dramatically increase the minimum
wage, and spend much of the surplus to funnel the proceeds to programs
to benefit "working families." Neither approach recognizes that
the only long-term answer to improving the economic well-being of Americans
is to focus on productivity.
In addition, neither liberals nor conservatives embrace fiscal discipline.
Conservatives would see the surplus go to tax cuts, not paying off the
debt. Some have even recently begun preaching supply-side Keynesianism,
arguing that large tax cuts are needed to spur consumer demand. Many liberals
continue to believe that because government spending boosts consumer demand
it leads to more jobs and in turn higher wages (but lower profits or higher
inflation since higher wages would have to result from increased bargaining
power by workers, not higher productivity). As a result, they attacked
efforts by the Clinton administration to pay off the debt, calling it
Calvin Coolidge economics. Yet, with full employment, cranking up large
new spending programs or tax cuts would only produce inflation and efforts
by the Federal Reserve to counteract the stimulative effect.
Growth economics also challenges the mistaken notion of natural limits
to growth. Until last year, most economists postulated that the economy
could not grow faster than 2 percent to 2.5 percent per year without sparking
inflation. Growth economics recognizes that the economy can grow much
faster without inflation, as long as productivity grows as fast. In fact,
the new administration should set a goal to double living standards for
American workers within 30 years. This would require maintaining an annual
productivity growth rate of 2.5 percent -- even less than the 2.7 percent
productivity growth rate the country has seen since 1996.
Embracing growth economics does not mean ignoring past economic policy
goals, such as job creation and inflation control. While these still matter,
they are no longer central. The information technology revolution, as
well as a highly competent Federal Reserve policy, has led to the longest
expansion in economic history. Because globalization, increased market
competition, and the technology revolution have reduced the threat of
inflation, the Federal Reserve does not need to induce anti-inflationary
recessions as much as it used to. Although as evidenced by its repeated
interest rate hikes in the last 18 months, the Federal Reserve Bank may
not have fully heeded its own lesson.
Growth economics has emerged because of the growing recognition that
the economic models created in the Industrial Age dominated by commodity
goods production no longer adequately explain growth in an economy powered
by knowledge and innovation.
While Keynesian and supply-side economics focused in an almost Newtonian
way on adjusting the demand or supply of capital and labor to keep the
economy in equilibrium, growth economics is focused on a different set
of questions related to how the New Economy creates wealth: are entrepreneurs
taking risks to start new ventures; are workers getting skilled and are
companies organizing production in ways that use those skills; are companies
investing in technological breakthroughs and is government supporting
the technology base (e.g., funding research, training scientists and engineers);
are regional clusters of firms and other institutions fostering innovation;
are we avoiding protecting companies against more innovative competitors;
are research institutions transferring knowledge to companies; and are
policies supporting the ubiquitous widespread adoption of the Internet
and other advanced information technologies?
Under the old economic policy model, it was not clear that there was
a role for government in economic policy beyond managing the business
cycle and protecting intellectual property rights. Growth economics makes
it clear that government policies can boost long-term income growth. It
recognizes the conservative insight that free markets, competition, and
innovation boost growth. But it also recognizes the liberal insight that
government investments, particularly in science, technology, education,
and skills, can provide a foundation upon which productivity growth depends.
And finally, growth economics recognizes that fiscal discipline underlies
all of this. As a result, growth economics leads to three overriding policy
prescriptions:
1) Invest in Knowledge. Economists have long agreed that technology is
the most important engine for economic growth. But their economic models
couldn't really say how technological innovation spurred productivity
or even occurred. New economic research not only recognizes the importance
of technical advances but also explains how the process occurs and describes
the key role of government in the process.
But it's not just technology that's key to productivity, it's the ability
of workers to develop and use technology. The New Economy requires higher
levels of education, including high-tech skills, and opportunities for
lifelong learning to keep up with the constantly evolving demands of the
Information Age.
As a result, growth economics focuses on increasing technological innovation,
including support for research and development in the public and private
sector, and on increasing the education and skills of the workforce and
the ability of firms to use these skills.
In 2000, the Progressive Policy Institute's New Economy Task Force proposed
a host of new investments in research and training. The new administration
should build on these recommendations and significantly support funding
for science, technology, education, and skills. For example, the next
budget should increase investments in federal civilian research by 10
percent (in real dollars) and continue that increase every year until
federal support for research is double today's level. The administration
should also increase funding for Department of Defense research. It should
not only make permanent the R&D tax credit but expand it. It should
provide incentives to companies to train workers and work with states
to jointly fund industry-led training alliances. And it should significantly
increase funding for scholarships and fellowships for science, math, and
engineering education.
2) Promote Competition and Innovation. Economists have long acknowledged
that competition keeps prices down. The New Economy creates another critical
reason for competition: It drives innovation and ultimately provides the
greatest benefits to consumers. The next administration should focus on
fostering economic competition through expanded trade and globalization,
economic deregulation, and promotion of e-commerce competition.
Global integration, open markets, and increased trade allow the U.S.
economy to specialize more in the higher value-added activities that it
does best. They also increase economic competition, keeping prices down
and fostering innovation. As a result, global integration is a key component
of growth economics.
Domestically, growth economics means that if government is to promote
growth it must facilitate, rather than resist, economic competition. This
means moving away from regulating monopolistic or oligopolistic industries
and instead promoting competition to achieve public interest goals of
lower costs, new products, and greater consumer choice. It also means
developing a modern understanding and application of antitrust law to
prevent anti-competitive practices.
Growth economics also means not giving in to special interests fearful
of change or falling sway to special pleading of incumbent firms threatened
by competition. These protectionists need to be rebuffed in a host of
areas -- including their opposition to bioengineered foods that promise
dramatic increases in agricultural productivity, their opposition to mergers
that promise heightened efficiencies, and their opposition to those seeking
government intervention to shelter them from e-commerce competitors.
Finally, it means crafting a legal and regulatory framework that supports
the growth of the digital economy, in such areas as taxation, privacy,
digital signatures, telecommunications regulation, and industry regulation
(in banking, insurance, and securities, for example).
3) Maintain Fiscal Discipline. While the Bush administration should significantly
increase investments in science, technology, skills and education, it
should also maintain fiscal discipline and continue to expeditiously pay
down the debt. Doing so results in lower interest rates enabling a virtuous
cycle of more investments, more growth, and greater surpluses to pay off
more of the debt. In a global market that disciplines nations for poor
fiscal policies, fiscal discipline is increasingly a requirement.
Historically, key economic policymaking posts have been held by economists
grounded in old economy macroeconomic theory. Most economists are not
trained in growth economics and do not understand the factors leading
to productivity growth. Princeton University economics professor Paul
Krugman reflects the conventional view when he states: "We [economists]
really don't know why productivity growth ground to a near halt [in the
'70s and '80s]. That makes it hard to answer the other question: What
can we do to speed it up?" Since Krugman (and most conventionally
trained economists) don't know the answer to this, he counsels us to "diminish
our expectations."
The principal advisers on economic policy to the new administration need
to be individuals who know how to speed up productivity and encourage
us to expand our expectations. Therefore, the new administration should
appoint individuals grounded in growth economics and technological innovation
to head the Council of Economic Advisers, the National Economic Council
(NEC), the Treasury Department, and other key economic posts (e.g., Department
of Labor, Department of Commerce). In addition, the new administration
should create a National Economic Policy Council as part of the NEC. The
council should be chaired by the vice president and include as members
the heads of major business and labor organizations, CEOs, university
presidents, and other civic leaders.
Finally, the new administration should support policies that increase
standards of living, embracing investment, tax, trade, and regulatory
policies that advance that goal and rejecting policies that do not. In
particular, it should significantly increase investment in research and
technology (including the associated mechanisms to utilize that technology)
-- as well as in the training and education of workers.
But at the same time the new administration needs to level with the American
people. We can either hold on to the old framework and possibly preserve
some semblance of the old economic security or we can embrace the New
Economy and growth economics. If we do, workers will face increased risks
and challenges (e.g., increased requirements to take control of their
own lifelong learning, higher risks of being displaced from a job), but
they will also reap greater rewards (faster income growth, more rewarding
work, and more free time). It is time for growth economics to replace
business cycle economics as the dominant organizing framework for U.S.
economic policy.
Blueprint Keywords: Extra Economics Extra Growth Econ
