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Stephen Olson at Chinese Development Institute Conference

 

 Clyde Prestowitz giving presentation to CDI...

 

Steve Olson teaching trade negotiations at the Mekong Institute...

 

Stephen Olson to speak at upcoming workshop organized by the International Institute for Trade and Development on 

"Economics of GMS Agricultural trade in goods and services towards the world market"

Chiangmai, Thailand Sep 8-12.

Op-Eds

(03/25/2001 - Morici) Destination Unknown | Reelin' And Rockin' Aboard The Bear Market Express

Destination Unknown | Reelin' And Rockin' Aboard The Bear Market Express: The Ride Nationwide | The Magical, Mysterious High- Technology Economy: Now You See It, Now You Don't
Peter Morici
1,677 words
25 March 2001
The San Diego Union-Tribune
1,2,3
G-1
English
(Copyright 2001)


It seems almost daily that another major corporation announces declining profits and layoffs. Adding to the public angst, the Dow Jones industrial average a week ago just suffered its worst week in 11 years, and the NASDAQ composite is off 63 percent from its peak a year ago. Because Americans now have 60 percent of their savings and investment in the stock market -- double the ratio in 1982 -- those statistics represents a loss of real wealth.

What happened to the fabled "New Economy" that was supposed to be our ticket to paradise? And how can we restore its luster?

The economic boom of the past decade has been remarkable. During an unprecedented expansion of the U.S. economy, we experienced four years of growth averaging more than 4.5 percent, unemployment falling to a 21-year low, and stocks soaring to record valuations -- all this without much inflation.

Restoring the magic will depend importantly on understanding the conditions that made the boom possible and the policies that helped derail it.

Despite the casual rhetoric often reported in the media, the U.S. economy is not, nor is it likely to be in 2001, in full-fledged recession -- defined as two consecutive quarters off declining economic growth. But rather than haggle over semantics, it is important to recognize that a weakened American economy is more vulnerable to risks in the global economy. For example, the cumulative weight of Japan's decade-long economic woes are beginning to take their toll on the U.S. economy. American companies and the stock market are likely to experience more pain before recouping lost gains.

At the center of the new economy were synergies generated by advances in telecommunications, microelectronics, software, and management practices. These unleashed innovations in the organization of work and the corporate supply chain, as well as a torrid pace in the introduction of new products and services. Together, these raised the sustainable level of productivity growth to levels not seen since the 1960s.

The avalanche of new products and higher productivity resurrected America's international competitiveness. Led by the high-technology sector, exports accounted for 25 percent of U.S. gross domestic product growth from 1989 to 1998, more than double the historical norm.

A flexible and high-powered labor market also kept wages from rising. Even as businesses expanded and unemployment fell, many firms boosted productivity by streamlining factories and management bureaucracies. Released workers joined even more rapidly growing firms and new enterprises.

At the same time, a tight labor market taught businesses the value of being good employers and, in particular, the virtue in training workers at all levels to upgrade their skills and prospects. In addition, immigrants -- ranging from computer programmers to food service workers -- helped fill gaps in the domestic labor supply.

Meanwhile, a strong dollar and falling oil prices helped keep import and energy prices low. Moreover, competition from imports pressured domestic firms to find new ways to boost productivity and encouraged businesses to embrace new technologies and methods, and to upgrade the skills of their workers rather than raise prices to grow profits and finance wage increases.

Finally, investments in technology to boost productivity fueled rapidly growing profits among leaders such as General Electric, Dell, Intel, and Microsoft, thus creating the optimism necessary to attract financing to start-up enterprises through venture capital and initial public offerings.

Unfortunately, forces beyond the control of U.S. policy makers, as well as some policy missteps, deflated the economy and the stock market over the last year. The Asian economic crisis, continuing malaise in Japan, and the rising value of the dollar significantly slowed the growth of U.S. exports and increased American purchases of foreign products after 1997. Moreover, oil exporting nations agreed in 1998 to cut production, and the price of oil began rising in early 1999. From July 1997 to December 2000, therefore, the annual trade deficit grew from less than $83 billion to $396 billion, creating a drag on domestic demand for goods and services equal to about four percent of GDP.

In addition, while the end of large federal budget deficits is cause for celebration, it is important to recognize that large government surpluses can constrain the demand for goods and services just as large trade deficits do.

It was a matter of considerable consequence, therefore, that the U.S. trade deficit began ballooning in 1997 at the same time that the federal budget swung from deficit to surplus. By FY 2000, the budget surplus had reached $237 billion, and in FY 2001 it is expected to reach $265 billion. At current levels, the trade deficit and budget deficit together place a drag on domestic demand in excess of six percent, and this could easily grow much larger in the months ahead.

As we moved through 2000, other structural constraints were also coming to bear. Federal government policies to reduce pollution through greater reliance on natural gas for electricity generation, coupled with limits on development of domestic oil and gas, created a tight natural gas market. Misadventures in deregulation created a shortage of electricity-generating capacity in California, with important consequences for other western states.

To compound matters, the Federal Reserve, alarmed by rising prices, raised interest rates six times from June 1999 to May 2000. Unfortunately, it was chasing inflation that monetary policy cannot catch. Most of the price increases were caused by: the tightening grip of the foreign oil cartel coupled with the limited supply of domestic energy; health care costs, which are fairly unresponsive to interest rates and the pace of economic expansion; and one-time events, such as the impact of the tobacco settlement on cigarette prices.

The last two interest rate increases came in March and May 2000, so that much of their effect occurred after the slowdown had begun. In 2000, GDP growth slowed from 5.6 percent in the second quarter to 2.2 percent in the third quarter and 1.1 percent in the fourth quarter. Instead of braking an accelerating economy, these rate increases helped push a besieged economy over the edge. Growth in corporate profits slowed, business investment dropped, and productivity growth fell significantly.

As for the stock market, while it may be irrational and overly exuberant at times, it has proved clairvoyant since last March. Investors recognized that slower-growing corporate profits did not justify high valuations for established companies. A slowing economy meant many young companies -- importantly, those financed by stock sales -- were unlikely to turn a profit soon and would need to sell more stock just to stay open. When stocks began sliding, investors were anticipating what ultimately happened in the real economy.

In response, the Federal Reserve has announced three interest rate cuts totaling 150 basis points since the start of the year. Unfortunately, we are relearning one of the oldest lessons of economics: monetary policy can choke a recovery but it cannot easily ignite one. Lower interest rates will not cause consumers to spend much more money -- Americans already spend almost everything they earn. Moreover, flagging investment is fairly resistant to rate cuts, because corporate decision-makers need to see more sales and profits on the horizon before they will trade in three-year-old computers for new ones or add expensive new capacity. And while lower rates can accelerate exports by weakening the dollar, it won't happen this time, because conditions in Japan and elsewhere in Asia make a weaker dollar and an export boom unlikely.

This time, fiscal policy must come to the rescue. Congress and the president must agree either to spend more of the budget surplus or give some of it back to taxpayers to spend for themselves.

Before writing your congressman to ask for a new bridge, however, it is important to recognize that federal taxes are now at a record peacetime high as a share of GDP and are only one-half percentage point less than their 1944 wartime record. Although we can quarrel about how much of the surplus should be spent on worthwhile public purposes and how much should be sent back to the people, it is not surprising that the president and Democratic leaders are debating the size and focus of a tax cut rather than whether we should have one at all.

Unfortunately, the president's tax cut plan will not give the economy the boost it needs. Of the $1.6 trillion, a significant share is earmarked for ending the estate tax, but individuals spared taxes on estates greater than $675,000 are not likely to run out and buy additional Ford Explorers or computers.

Furthermore, because the Bush plan calls for cuts in income tax rates in 2001, 2003, 2005 and 2006, a good deal of the $958 billion slated for income tax relief will not find its way into taxpayer pockets and consumer spending right away.

To get the economy moving again, tax relief should be accelerated. In particular, it would be better to compress the schedule for income tax cuts, even if this required reducing the ultimate size of rate cuts or limiting estate-tax reductions to stay within a total tax package the president and Congress could accept. Further, cuts could be considered after the next election cycle if conditions warrant.

Importantly, the fundamentals are still in place for rapid productivity growth and the opportunities that creates. These fundamentals include continuing advances in new technologies and the very flexible and resourceful American work force.

Congress and the president need to show some creativity -- and flexibility, also -- to get the economy and the country back on track.

Peter Morici is a senior fellow at the Economic Strategy Institute in Washington, D.C.

 

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