Clinton's Bequest Reconsidered

Will Bill Clinton's brand of fiscal prudence save liberalism—or kill it? An economist and a journalist discuss the president's economic policies and the hidden dangers of fiscal conservatism.

Barry Bluestone on Fiscal

Conservatism's Hidden Dangers

It was wonk heaven. Flush from his victory over George Bush in 1992, President-elect Bill Clinton convened more than 300 economists, social scientists, labor leaders, and corporate executives for a two-day economic summit in Little Rock to prepare for his January inauguration. The incoming president focused on the big questions. How important were the budget deficit and interest rates? How much pump-priming could we get from a middle-class tax cut? What could be done to stem the runaway cost of health care? How much should we be investing in education, basic research, and public infrastructure?

In Putting People First, his campaign manifesto, Clinton had stressed the importance of public investment in the economy and an active partnership between the government and the private sector. At the summit, he hinted that while he might drop his $30 billion anti-recession fiscal stimulus package, he would nevertheless pursue long-term public investment. When Henry Aaron, a well-respected Brookings economist, warned the new administration to resist calls for new public outlays and concentrate on cutting the deficit, the president-elect countered, "All spending is not the same. There is plainly a difference between spending money and investing it. We have got to change the character of federal spending" toward investment. The president-elect was dead right.

But even as his public investment rhetoric still lingered in the public ear, the president was soon casting his lot with budget balance. And now, eight years later, Clinton's supporters, looking as eagerly for a legacy as the man himself, have created a narrative that casts Clinton as the architect of a new strategy of prosperity based on piling up surpluses, reassuring money markets, and eliminating 165 years of federal debt.

According to conventional wisdom, the results of Clinton's fiscal conservatism have been nothing less than stunning. America is now enjoying one of itsgreatest periods of growth ever. Unemployment has hit a 30-year low. Inflation is almost nonexistent. The stock market has climbed from 2,000 when Clinton took office to almost 11,000 today. What Bennett Harrison and I have called the "Wall Street-Pennsylvania Avenue Accord" seems to have miraculously turned the economy around from stagnation to exhilaration. Focusing "like a laser" on killing off budget deficits and thus the government's voracious appetite for borrowing presumably provided the low interest rates that have allegedly spurred investment while boosting consumerdemand, particularly among those who feel newly rich because of the mushrooming value of their stock portfolios.

Lloyd Bentsen, Clinton's first Treasury Secretary, had promised his boss that if the White House worked to reduce the budget deficit, Wall Street would reward the economy with a new spurt of growth. The advice appears to have worked so well that Clinton and his advisers—and his vice president—have now concluded that if reducing budget deficits is good, cutting them to zero must be even better, and running outright surpluses must be best of all.

Jonathan Chait [see "Clinton's Bequest: The Liberal Uses of Fiscal Conservatism," TAP, December 6, 1999], along with pretty much everybody else, now credits the nation's new fiscal conservatism with bringing about the economy's resurrection. But in this story the cause and effect are out of sync. The just-released revised Gross Domestic Product (GDP) growth statistics show that fiscal conservatism deserves little credit. The slump of the 1970s bottomed out in the 1981-82 recession. Productivity growth, the basis for GDP growth, increased from0.8 percent during the Carter years to 1.6 percent during the Reagan presidency, to 1.7 percent under Bush's watch, to 2.1 percent in Clinton's term.

So the economy was already beginning to improve in the era of rising Reagan deficits, and then accelerated further when the deficit began to close. Within wide limits, the size of the deficit has had little to do with the ability of the economy to expand. Indeed, the expanding economy has been responsible for most of the deficit reduction we have experienced, not the other way round. Of course, if we had continued to pile up deficits in excess of 4 percent of GDP, the escalating debt would have eventually stymied growth. But it does not follow that permanent surpluses are the key to economic health. Even low interest rates, while sometimes a tonic for reversing sluggish growth, are not chiefly the result of deficit reduction. Real interest rates (adjusted for inflation) were actually lower in the high-deficit days of the early 1990s than they are today. Jonathan Chait has mistakenly embraced the old theory of "crowding out"—the idea that government borrowing invariably crowds out private investment by driving up the cost of money. But the statistics show that this just isn't so. High productivity growth permits prices to stabilize and begets lower interest rates. Chait has cause and effect backwards.

The real reason productivity and economic growth began to rise in the 1980s and have accelerated in the 1990s has little to do with balanced budgets, low interest rates, or stock market buoyancy. It has much more to do with the long-run impact of the technological revolution that has been underway for now nearly three decades. Whenever there has been a fundamental breakthrough in technology—say, the introduction of the steam engine—the initial impact on productivity growth has been minuscule or even negative. This is not surprising, for when a startling new technology is introduced, it takes a long time to figure out how to apply it. Hence, it took some two decades for the steam engine to reap a productivity premium, and the same was true for electric power.

Which brings us to the information revolution. It too has had a long gestation period as industries have been moving down the "learning curve" and the "diffusion curve" normally associated with any true scientific breakthrough. It is not surprising that productivity slumped in the 1970s near the beginning of the revolution, or that productivity began to pick up during the 1980s as more and more industries learned how to use computers and software more effectively. The full-scale productivity premium is only just now being realized. The latest boost in productivity from the information revolution occurred happily on Clinton's watch—but not because of anything he or his fiscal policies did. (And given that Al Gore did not invent the Internet, one can hardly credit the vice president with the economy's renaissance either.) With or without the fiscal conservatism of the administration, the economy would be in pretty good shape today.

But pursuit of fiscal conservatism will almost surely undermine the rate of economic growth early in the new century. While the information revolution was in large part the brainchild of scientists and engineers working in university laboratories and research facilities at private companies, much of the initiative and funding for this research came from the government. The need for massive computing power to run modern defense systems led to the construction of powerful mainframe computers. The need for miniaturized guidance systems for ICBMs and NASA rockets led to the development of microprocessors and the software the rockets use. The federal government's investment in the ARPANET led to the modern-day Internet and the World Wide Web. Moreover, investments in education and training helped prepare a work force to operate the wondrous new commercial applications of these technologies.

Without these public investments, today's ubiquitous "e-commerce" would have been delayed by perhaps decades. It is no wonder that the United States leads the world in applied information technology. The investments the federal government made in these technologies have put American firms from Intel and Microsoft to Sun, Dell, Apple, Hewlett-Packard, and Compaq well ahead of the global competition. Similarly, medical research emanating from government-funded laboratories has provided us with a head start in biotechnology, scanning devices, and a range of pharmaceuticals.

But here's the bad news. The federal government has been slashing its funding of basic research and public infrastructure—and even education and training—as a share of GDP. If you are going to try to build up the largest surplus possible and put budget caps on spending, public investment is going to suffer. And that is precisely why Clinton's fiscal conservatism is so dangerous; it could further strangle public spending.

Since 1979, the share of federal investment in public nondefense infrastructure, education, and research has fallen steadily. And under the Clinton budget and the congressionally imposed spending caps, such investments are destined to decline further. Total discretionary federal funding(excluding Social Security, Medicare, Medicaid, and interest on the federal debt) was 13.6 percent of GDP in 1968. Even as late as 1986, it amounted to 10 percent of GDP. Twelve years later, it was down to 6.6 percent; it is scheduled to fall to only 5.5 percent by 2004. Hence, by the middle of the next decade, the federal government's role in underwriting economic activity will have declined by more than half. And it is those very areas of spending that have been most essential to our economic growth that are being cut most deeply. According to the National Science Foundation, the federal share of support for the nation's research and development first fell below 50 percent in 1979, then to 44.9 percent in 1988, and is projected to drop to only 26.7 percent for 1999.

We will pay for our fiscal conservatism dearly. What technological innovations might be missed or postponed, we will never know. But it is clear from an increasing amount of economic research that the single most important factor behind long cycles of prosperity is the level of technological advance—not whether we balanced the federal budget or reduced long-term interest rates by a few basis points. Moreover, the government is an essential partner in the research game for a simple reason. The short-term perspective of businesses—the need for an immediate payoff—means that high-risk, long-term, basic research has a low priority without government. You need someone to throw good money at basic research for powerful innovation to occur. And only the federal government has the means and the patience to do this.

President Clinton's supporters say that his fiscal conservatism has made the world safe for liberalism again. By fighting hard to reduce deficits—from the 1993 tax increase passed by a Democratic Congress to the 1997 deficit-reduction deal brokered with a Republican Congress—Clinton has won credibility for the Democrats in economic policy. Even if the current boom is not entirely the fruit of deficit reduction and lower interest rates, as the Wall Street School would say, it has created the conditions for people to be more accepting of minor government efforts to serve traditional Democratic constituencies.

This is the "inoculation" theory of government, to borrow a phrase from my Northeastern University colleague Charles Euchner. Clinton has inoculated the Democrats against the charge of being soft on crime by supporting the death penalty and three-strikes laws. He inoculated Democrats against the image of "countercultural McGovernism" with all his talk of family values, school uniforms, and V-chips. He has eveninoculated the Democrats against charges of being soft on welfare moms, by championing and signing the 1996 Republican-backed welfare bill. And now Clinton has inoculated the Democrats against charges of government recklessness by embracing the commitment to balanced budgets of pre-Reagan Republicanism.

This may have been good and necessary politics. But as Chait's article and Vice President Gore's warnings against fiscal profligacy suggest, Clinton's larger legacy has been to paralyze public investment, perhaps for decades. Both parties now consider budget balance a mark of necessary fiscal and economic virtue.

It might have been different if this consummate educator of a president had continued to lead by teaching as he had at the 1992 Economic Summit. If we'd had a legitimate national conversation about what types of public investment make a difference and what forms of public-private partnership work best to ensure growth with equity, we might today be able to have our cake and eat it too. The goal should be to have not only a current economy so strong that deficits disappear, but a commitment to public investment that ensures sustained prosperity for another generation to come. The problem with the inoculation theory of government is that it accepts the terms of the disease. As progressives, we can do better than confining ourselves to Wall Street nostrums in developing national priorities for the next century.

Jonathan Chait replies:

In my article, I wrote that the deficit reduction of 1993 helped the economy in three ways. First, it allowed the Federal Reserve to keep short-term interest rates low. Second, it spurred the bond market to lower long-term interest rates. Finally, it freed up capital for private investment, hence raising productivity. The first two points are hard to dispute, and Professor Bluestone does not dispute them.

The third point (as my article conceded) is, by its nature, unprovable, but it has strong evidence behind it: Since 1993, national saving has risen, private investment has grown, and productivity growth has shot up.

Bluestone argues that deficit reduction has not contributed to economic growth; as evidence, he states that productivity was already beginning to grow from the Carter era, through Reagan and Bush. But it is strange to break down productivity growth by presidential administration. It makes much more sense to examine business cycles because productivity always grows as an economy comes out of a recession. From 1973 to 1980, productivity grew, on average, 1.2 percent a year. From 1980 to 1990, it grew 1.4 percent—barely higher. Since 1990, it has grown 2 percent annually. This hardly proves Bluestone's contention that "the size of the deficit has had almost nothing to do with the ability of the economy to expand."

Also, fiscal conservatism is not synonymous with "cutting spending," although Bluestone argues as though I thought that it was. A large share of the deficit reduction of 1993 came by the raising of taxes, and, in the current context, fiscal conservatism means resisting tax cuts. And even if you are going to put a lid on the budget, investment is such a small share of federal spending that it is possible to fund it generously and cut other programs. Clinton has not been nearly as bad at funding research anddevelopment as Bluestone suggests. Most of the spending reductions have come in defense; nondefense research-and-development spending has held steady at 0.4 percent of GDP, which means that it has grown well ahead of inflation.

Should Clinton have spent more? Sure. The point of my piece was not to defend every budget line of the Clinton era, but to offer a general philosophical approach that marries fiscal conservatism with the progressive impulse. Progressive fiscal conservatives want to increase public and private investment. President Clinton has done better at the latter than at the former, but, as I stated in my piece, this was deviation from progressive fiscal conservatism, not a necessary consequence of it.

Bluestone responds:

The debate that Jonathan Chait and I are having about fiscal conservatism and deficit reduction is really quite fundamental, on both economic and political grounds. Mr. Chait argues that interest rates are the key to growth and that deficit reduction has kept interest rates low in the late 1990s. There are two problems with this argument. The first is that the real interest rate (the prime rate that lending institutions charge their borrowers) was actually lower in the high-deficit boom years 1988 and 1989 (when real GDP rose by 3.8 and 3.4 percent, respectively) than during the late 1990s (when the economy was growing at a similar rate with deficits falling). So there is not even much of a correlation between interest rates and the deficit, let alone a strong causal link.

The second problem is that the level of interest rates is only one factor in corporate investment decisions. If corporate managers believe thataggregate demand willremain strong, they willinvest in new plants and equipment to make sure they have the capacity to fulfill their consumers' needs. A somewhat higher interest rate will not—and empirically has not—deterred them from such investment. But in his original article, Chait suggested something else as well—that Alan Greenspan essentially blackmailed Bill Clinton into fiscal responsibility, threatening to send interest rates through the roof if the president did not make deficit reduction the very core of his economic policy. Perhaps this is so, but in this case we are much worse off than we imagined. No doubt, if Clinton had snubbed Mr. Greenspan and had said that he didn't care how high the deficit went, the Fed would have raised interest rates to the sky. But that doesn't mean the Fed would have raised them if the deficit were cut more slowly or if the present policy were not based on a fatal obsession with building up the biggest budget surplus possible. Greenspan, I hope, is savvy enough torefrain from destroying the world economy simply to rough up the president.

Mr. Chait also suggests that the government's revised statistics indicate there was not much improvement in productivity until after the deficit reduction was in place. But whether you measure productivity rates according to presidential terms in office or by business cycle peaks, the result is the nearly the same. Already by the mid-1980s, productivity was booming in the manufacturing sector. It would take the 1990s to bring technology-induced productivity improvements to the service sector. Once we had productivity running on both cylinders, the economy boomed. Again, this was hardly related to federal deficits or even much to interest rates.

So the drive for the biggest federal surpluses now underway will do little to spur short-term growth. Worse yet, because of the dramatic cuts in public-sector research and development, infrastructure, and education and training, which were needed to eliminate the entire federal debt, this misguided economic strategy will almost surely sabotage growth in the long run. Mr. Chait doesn't worry too much about the cuts in publicly funded research and development, arguing that the big cuts have all come in defense. But much military research-and-development money has always been in the Department of Defense and NASA—and these agencies have been funded throughout a good deal of the information technology revolution. If we are going to cut these dollars from the Pentagon—a policy I endorse—we should at least transfer them to civilian equivalents such as the National Science Foundation and the National Institute for Science and Technology.

Maybe in the end, Clinton needed to take his fiscal surplus stand to forestall economically ruinous tax cuts by the Republicans. But if the only two positions on the political spectrum are giant budget surpluses or giant tax cuts, we need desperately to expand the political spectrum. If we don't, we will all pay the price.

Chait's Last Word:

Professor Bluestone characterizes my view as "deficit reduction has kept interest rates low" and "interest rates are the key to growth." In fact my view is nowhere near that reductive. Deficit reduction contributes to low interest rates, and low interest rates contribute to prosperity. Since lots of factors affect interest rates, it's not very useful to compare them from year to year. Deficit reduction may have increased the supply for capital, which would tend to lower the price of money, but increased optimism may have increased demand, which would raise the price of money. In any case, the prime rate, which Bluestone uses, is not the best or most common measure of interest rates. The rate on government bonds, a more frequently cited gauge, is in fact much lower than it was 10 years ago.

Bluestone also characterizes my argument about Greenspan in an overly stark way. There is a continuum of options on fiscal policy, and Greenspan has a continuum of options on monetary policy. He has said that tighter fiscal policy allows looser monetary policy. It is not a dichotomous choice between low interest rates and "wrecking the world economy." I should also clarify that I do not favor "building up the biggest surplus possible," which would entail raising taxes and cutting spending. It's possible to run a surplus now simply by keeping spending constant in real terms and not cutting taxes. A policy of progressive fiscal conservatism, in my view, is the best way for the United States to sustain economic growth while still spending government money on social programs and public investment.