Boom Boom: '90s Beat the '80s
By Martin N. Baily, chairman of the president's Council of Economic Advisers.
Wall Street Journal 2000-02-25
What accounts for the current economic expansion, the longest ever recorded? The debate over this question is important, not to dole out bragging rights but to be sure we have the right policies to sustain it. Comparing this expansion with the 1980s helps us learn lessons for the future.
The two expansions share some noteworthy similarities. In both, technological innovation and private-sector dynamism played an important role. Both were helped by monetary policies that reduced inflation while accommodating growth. Both had government policies that emphasized deregulation and open trade. And both expansions began with considerable industrial restructuring.
But in crucial respects, the expansions are different. The '80s expansion featured fiscally irresponsible tax cuts even as government spending grew rapidly. This led to skyrocketing deficits that quadrupled the debt, to $3 trillion in 1992 from $712 billion in 1980.
The '90s expansion, by contrast, has featured fiscal discipline. The watershed event was President Clinton's 1993 budget plan, which reversed the trend of growing deficits. Thereafter, as a result of the policies of both the president and Congress, the federal budget has gone from a projected $455 billion deficit this year to a $167 billion surplus--a $622 billion swing. According to the Congressional Budget Office, the budget deficit has declined each year since 1993, even after adjusting for the effects of the strong economy.
It is ironic that for all the talk of supply-side economics, the expansion of the '80s was heavily driven by the stimulus of government-induced demand. As the stimulus from the tax cuts and defense buildup wore off, the expansion flagged, in part dragged down by high real interest rates, which, despite the slow growth, were 50% to 90% higher on average than in the current expansion. As the '80s expansion matured, the pace of investment and research-and-development spending slowed down, and net domestic investment as a share of gross domestic product declined. In response, capacity growth slowed to a crawl, inflation accelerated, and productivity growth became progressively slower--averaging less than 1% a year over the last four years of the expansion.
Martin Feldstein, when he was chairman of President Reagan's Council of Economic Advisers, warned of the consequences of the '80s fiscal policy. The 1984 Economic Report of the President states on page 37: "The most important long-term economic effect of the prospective budget deficits would be to absorb a large fraction of domestic saving, and thereby reduce the rate of capital formation and slow the potential long-term growth of the economy." Too bad his warning was not heeded at the time.
The expansion of the '80s also left a legacy of financial institutions in turmoil and an economy mired in debt. Some now make light of the recession that followed and forget how anemic the initial years of the recovery were--unemployment remained at 7% or above for 21 months. The legacy of '80s fiscal imprudence was an important reason why, in early 1993, most observers forecast deficits as far as the eye could see.
The expansion of the '90s, by contrast, has been driven heavily by private-sector demand and investment made possible by fiscal discipline. The expansion began slowly and gathered momentum over time. Spurred in part by lower interest rates, growth in equipment and software investment was far higher than normal--averaging 12.3% annually from 1993 to 1999. In the 1980s expansion, investment accounted for just 22% of the rise in GDP. By contrast, in the '90s, 36% of the growth reflected higher investment.
As the '90s expansion has advanced, it has become increasingly vigorous: The pace of investment and R&D spending has accelerated, capacity growth has kept pace with output, and productivity growth has climbed to 2.9% a year over the past four years. As unemployment rates have been reduced, poverty rates have fallen and real earnings and incomes have grown robustly for all income groups. Moreover, throughout the expansion, the core inflation rate has dropped, falling in 1999 to 1.9%, its lowest level in 35 years.
This record suggests two important lessons. First, while it is undoubtedly true that the technological innovations associated with information technologies have played an important role in the '90s expansion, it is important to recognize how government policy has helped. The shift to fiscal discipline, together with astute monetary policy, started a favorable reaction that spurred growth and generated lower deficits, followed by more growth and finally budget surpluses.
Second, some would have us believe that leadership in Washington has a Pavlovian response to higher revenues: If the money comes in, the politicians will find a way to spend it. The past decade clearly refutes this idea. The record shows that although revenues have increased, government spending as a share of GDP has been reduced to its lowest level since the 1960s.
Some would also have us believe that the expansions of the '80s and '90s are really just part of one long expansion, but these are two distinct and separate expansions. This expansion is getting stronger all the time, and there is no reason it should end any time soon. The right policies can make sure it continues.
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