When Vice President Al Gore promised to retire the national debt by 2013 and even to run surpluses in the case of a recession, I assumed that he was merely trying to score a political point by contrasting his own fiscal conservatism with the recklessness of rival George W. Bush's proposed tax cuts. But after reading Treasury Secretary Larry Summers's speech on the "new wealth of nations" in San Francisco (May 10) and talking to Summers himself, I've decided that Gore's statements reflect a significant change in his and the administration's economic philosophy.
Gore and Summers, who is among Gore's closest advisers, now advocate running surpluses not simply as a guard against inflation in a time of full employment--the old Keynesian rationale--but as the most positive means of sustaining the current prosperity. No administration or presidential candidate has advocated this kind of fiscal policy since the Republican administrations of the 1920s.
Gore and Summers's new outlook represents the third stage in the Clinton administration's evolution away from the fiscal policy that dominated the Kennedy, Johnson, and Carter administrations. The first stage came about during the White House negotiations over its first budget in 1993. Clinton, influenced by Robert Rubin, who was then head of the National Economic Council, chose to give greater priority to reducing the federal deficit than to increasing public investment, even though unemployment was over 7 percent. Rubin and other deficit hawks argued that by reducing the deficit, the administration would persuade Federal Reserve Chairman Alan Greenspan to lower interest rates and would also reduce market pressures for higher rates. Lower interest rates would stimulate the economy far more effectively than increases in the size of the federal deficit, which would be met by higher interest rates.
This argument never really touched basic assumptions because Rubin was not advocating balancing the budget, only reducing the projected size of the deficit, while his critics were also not advocating an increase in the size of the projected deficit, but only a smaller decrease. No one at the time advocated running surpluses and retiring the debt--a position that for decades had been limited to grizzled pamphleteers from little towns in Florida and Arizona who would show up at conservative conferences in Washington.
The second stage in the evolution of a new fiscal policy occurred at the beginning of Clinton's second term. At the time, Rubin, who had become secretary of the Treasury, convinced Clinton to oppose a Republican proposal for a constitutional amendment to balance the budget precisely because it would tie an administration's hands in the case of an economic downturn. Rubin didn't oppose balancing the budget for 1998 or 1999. He thought it was a good idea because he saw the country approaching full employment, but he remained committed to the Keynesian strategy of using deficit spending in the case of a sharp downturn. What had changed was the Treasury's view of the business cycle. On the basis of a technical paper by former Treasury Department economist Dan Sichel, Rubin and Summers had become convinced that, in the absence of external shocks, they could prevent any downturn from occurring, with the proper mix of fiscal and monetary policy.
Treasury and White House officials also believed that it was important for the administration to show that it could balance the budget in order to erase the public's image of the Democrats as the "tax and spend" party. Once the Democrats had laid that reputation to rest, they could resume proposing ambitious spending programs. In January 1997, one Treasury official told me that he expected that if the Democrats won both the White House and Congress in 2000, they might then initiate the kind of programs that the Clinton administration had contemplated during the 1992 campaign.
But now--after two years of budget surpluses and record economic growth--the third stage is occurring. The administration's outlook is most clearly expressed in Summers's speech at the technology conference in San Francisco. In that speech, Summers distinguished between the old economy based on the production of goods and the new economy based on the production of ideas and information. But he also made a parallel distinction between periods when rates of investment and profit are low, like the 1930s and the 1970s and 1980s, and periods when they are unusually high, like the 1920s or the present. For instance, at no other time since World War II have the rates of gross private investment and of profit on assets been as consistently high as they have been since 1994. The only period that comes even close is the early 1960s.
In some of these prior periods, there was a relative absence of prof-itable investment opportunities. Government's role during these periods, according to Keynes's theory, was to induce investment through deficit spending. Deficit spending--whether in the form of public works, military expenditures, or even tax cuts--created demand for private goods and inspired private investment that would not otherwise have taken place. Deficit spending pulled the United States out of the Great Depression and out of steep recessions in the mid-1970s and the early 1980s.
But what makes this period and the 1920s different is the introduction of new capital and consumer goods undergirded by dramatic innovation. In the 1920s, it was electricity and the automobile; in the 1990s, it was information technology that took the form of capital and consumer goods. In his speech, Summers contrasted the negative effect of the energy crisis of the 1970s with the positive effect of information technology today. The oil shock introduced "a sharp price increase in a sector that was important to many other parts of the economy--and everything bad happened." Information technology has produced "accelerated productivity growth, lower unemployment, lower inflation, and enormous benefits to our country." Rising demand for goods has not resulted in the old cycle of higher prices, greater investment, overproduction, and bust, but in lower prices and greater investment and growth.
If the proper government strategy in the older economy was to prop up investment through deficit spending, the proper government strategy in the new economy is to make sure that high rates of investment are sustained by keeping interest rates low. Government can best accomplish that, Summers argues, by running surpluses and retiring the debt. Retiring the debt creates a virtuous cycle: It contributes to lower interest rates, which in turn lower interest payments on the debt and thus create a greater surplus and the opportunity to retire still more of the debt. Instead of government bond purchases "crowding out" private investment, reduced purchases "crowd in" private investment. Says Summers, "In a world that is rich with investment opportunities, and where investors are all able instantly to compute the implications of changes of policies five and 10 years out--the importance of running a surplus and pursuing prudent policies becomes much, much greater."
Bush's proposed tax cuts might spur investment by creating new demand for goods, but they could also lead to higher interest rates and to the demand for goods being siphoned off by imports, as happened with the deficits of the 1980s. In addition, Bush's regressive tax cut would exacerbate the inequality that seems intrinsic to the new economy. To Summers and Gore, retiring the debt is a more efficient and fairer way of keeping prosperity going.
Summers and Gore's outlook does not necessarily represent a new economic theory, but it does represent a new policy--one that in its optimism and emphasis on surpluses recalls that of Andrew Mellon, who served as secretary of the Treasury under three Republican presidents in the 1920s. Theoretically, the administration's view is by no means a break with Keynes, who advocated running surpluses at times of full employment. But in its view of economic history--and of the way major innovation can create the basis for a new wave of growth--it owes much more to Russian economist Nikolai Kondratieff and to Austro-American Joseph Schumpeter than to Keynes. Summers describes the new economy as "Schumpeterian."
If Gore is elected, this new outlook will certainly influence his domestic policy. The need to maintain surpluses and retire the debt rules out the kind of ambitious social and economic programs that Clinton contemplated in the 1992 campaign. If the administration undertakes any major new expenditures, it will be in education, which would be designed both to enhance the value of the information economy's human capital and to equalize the opportunity for success in the new economy. Expect, therefore, a Gore administration to emphasize greater funding for public schools and for higher education, but not to propose universal national health insurance or major expenditures on urban infrastructure.
The new outlook also has implications for the administration's international economic policies. Summers told me, "There are some disturbing parallelisms with the 1920s, not so much in terms of financial conditions, but in terms of America turning inward." Administration officials worry that opposition to international institutions could cause the same kind of breakdown of trade and diplomacy that helped turn the crash of 1929 into a long-term depression. They are therefore particularly concerned about maintaining an open trading system through the World Trade Organization. Gore shares this concern--even if he told the AFL-CIO Executive Council in New Orleans last February that he would insist on labor conditions in trade treaties and would have negotiated a much tougher deal with China.
Is the new administration's view right? I can't pretend to evaluate its economic assumptions, but its success as policy clearly depends upon the absence of international shocks and upon a relatively quiescent public that is willing to accept the inequality and insecurity of the new economy in exchange for a slowly rising standard of living. Administration officials think the public does support the administration's strategy. Summers says that while the administration has focused on public priorities like education and promoting opportunity in areas that have been left behind, he has failed to detect either pronounced public resentment toward the new rich or pressure for programs like universal health insurance. But it seems to me that on both these counts, there is reason for Gore and Summers to worry. The Asian financial crisis of the late 1990s came close to plunging the world economy into recession. Similar shocks could be in the offing. If they do not occur, and if the United States enjoys a continued boom, then a new Gore administration could suffer from the very success of its policies. Just as happened during the early 1960s, continued prosperity could breed higher expectations and reduced tolerance for callow billionaires and parsimonious federal policies. ¤