THE ACTIVISTS ITCHING TO PUT THEIR STAMP ON THE ECONOMY
Will economists matter again?
It's been 30 years since the profession sent its "best and brightest" to serve on President Kennedy's Council of Economic Advisers in Washington. For a few years, the macroeconomic magic seemed to work, and economists began to believe they might tame the business cycle forever. Then came the Great Society, Vietnam, guns and butter, OPEC, inflation, and stagflation. By the time Ronald Reagan took office in 1981, economists and economic activism were thoroughly discredited. Less government and lower taxes became key objectives, and few economists--save supply-side cheerleaders--were needed to spearhead the laissez-faire cause.
With the election of Democrat Bill Clinton to the Presidency, economic activism promises to take hold in Washington again. A battle for Clinton's heart and mind has already begun, with briefing books being readied for the President-elect (page 104). Clinton will soon host a conference of business leaders, economists, and others to produce a "national audit" of the economy.
SLEW OF ILLS. The activism that evolves in Washington promises to be of a new kind. Two decades of costly and poorly conceived government spending left the economy with a huge budget deficit and an unsolved slew of social ills. Jobs and incomes, meanwhile, have been squeezed. Confronted with these conditions, most economists have become both more humble and more flexible. Those hankering to get to Washington may be schooled in techniques of stimulating demand, but now they are focusing on investment, research, and training to buoy the supply side of the economy.
Call it supply-side activism--though it is as different from Reagan's supply-side philosophy, which advocated cutting marginal tax rates, then leaving the economy alone, as night is from day. Today's activists have seen incomes polarize and the budget deficit widen. Their vision is to focus on how best to help people and businesses grow again.
The ascendancy of major competitors, from Germany to Japan and beyond, forced economists of all political stripes to examine how and why some countries and industries advance while others retreat. Today, many economists, even some conservatives, concede that there is a critical role for government to play in fostering growth, though they still disagree on tactics. Even if only a few academics make it to Washington as advisers, their work could provide the intellectual underpinnings for a 1990s brand of activism--one that aims to be fiscally responsible as well as socially effective.
" `Hard heads and soft hearts' is a good phrase for what's needed," says Lawrence H. Summers, chief economist of the World Bank. Summers, one of numerous economists rumored to be in the running for a seat on the Clinton CEA, echoes Princeton University economist Alan S. Blinder, also a CEA prospect. Blinder, a BUSINESS WEEK columnist, penned Hard Heads, Soft Hearts, subtitled Tough-Minded Economics for a Just Society, before the 1988 Presidential election. Another CEA candidate, Rudiger W. Dornbusch of Massachusetts Institute of Technology, urges Clinton to be aggressive about cutting the deficit even as he proposes new programs.
EXTRA LIFT. The CEA may end up being co-equal or even subordinate to an Economic Security Council. If such a body is formed within the White House, it will likely be headed by a member of Clinton's inner circle--possibly Professor Robert B. Reich of Harvard University's John F. Kennedy School of Government. Both Reich and fellow Clinton adviser and business consultant Ira Magaziner advocate an aggressive competitiveness strategy. Recent research is giving their views on infrastructure, technology policy, and training an extra lift.
The first item on any Clinton agenda will be to ensure that the recovery picks up steam. By now, virtually all mainstream economists have fallen into step with calls for economic stimulus along the lines of the $20 billion or so in infrastructure spending of the Clinton plan. MIT economist and Nobel laureate Robert M. Solow, a onetime staffer on Kennedy's CEA, has favored even more aggressive stimulus. He, too, is said to be under consideration for the CEA.
Infrastructure spending--a version of old-fashioned public works--would take government beyond the familiar demand-management of the 1960s. Ironically, it's a conservative economist who has provided much of the recent ammunition in support of such spending. David Aschauer, who studied at the University of Rochester and now teaches at Bates College in Lewiston, Me., set out to learn whether infrastructure spending was different from other forms of government spending. His research led him to conclude that the drop-off in public spending on roads and bridges in the U.S. over the past two decades had a large and measurable impact on the rate of private investment, productivity, and overall growth.
SOCIAL RETURNS. Aschauer's work is but one example of research in what economists call externalities. An externality is something outside the ability of an individual consumer or business to control, but which nonetheless has a significant impact. A positive externality, for instance, might be a scientific discovery that quickly enters the public realm and can be used by hundreds of manufacturers, not solely by its inventor. A negative externality could be a poor, declining school system, whose graduates tend to narrow the pool of skilled workers available for hire by local employers.
The World Bank's Summers, for instance, suggests that there may be significant externalities or social returns from rapid capital accumulation. If so, the case for encouraging capital investment through an investment tax credit or some other device is very strong. Here, the objective is to focus on the supply of capital in the economy. Summers has shown that a rise of one percentage point in the machinery-investment share of output is associated with an increase of 0.26 percentage point per year in the rate of economic growth.
MIT economist Paul R. Krugman--still another CEA prospect--has examined the imperfect competition and externalities that mark global trading relationships. Although Krugman doesn't endorse protectionism, his findings have pointed the way for advocates of "managed trade," who favor government intervention to secure market shares.
Laura Tyson, international economist at the University of California at Berkeley, believes that bilateral arm-twisting may at times be necessary with such trade adversaries as Japan. But she adds that trade policy is "not an adequate substitute" for a domestic technology policy to develop and promote leading technologies in America. Tyson helped Reich to draft documents for the Clinton campaign.
Technology policy is a tent under which growing numbers of academics and businesspeople are gathering, and it, too, addresses the supply side of the economy--the supply of ideas. Today's growth theorists argue that the biggest source of growth in the economy-at-large is knowledge. And since ideas and innovations become widely available so quickly, their originators can't hope to capture outsize rewards. Thus, the diffusion of knowledge must be pursued as a public good, argues Paul M. Romer, economist at the University of California at Berkeley.
Romer, who was trained at the conservative economics department of the University of Chicago, frets that government may muck up this process. Instead of having government plow dollars into research and choose which technologies and industries to support, he suggests that companies be allowed to set aside money that they then could allocate to research consortiums. Government would simply write the legislation allowing companies to pool research money.
`PEOPLE FIRST'? Perhaps the most important consideration for the new activists will be people. Clinton has vowed that his policies will "put people first," and the data on income growth and inequality show why that's so important. Researchers of both liberal and conservative bent have demonstrated that wage shifts over the past couple of decades have led to greater income inequality.
While explanations of the increasing income inequality vary, Lawrence F. Katz of Harvard University and Kevin M. Murphy of the University of Chicago attribute it to rapid secular growth in the demand for more-educated and better-skilled workers. Katz, who crunched numbers on the national and Arkansas economies for the Clinton campaign and might end up as a staff economist at CEA, argues that there's a role for education and training in ameliorating the social effect of these trends.
Most economists today still worry that economics and politics don't mix and that government inevitably will screw up the best-laid plans. Still, the profession has come a long way in figuring out the nature of many economic and social problems. Today, many economists are ready to take a chance on new ideas. "Like with a garden, you have to keep weeding," says MIT's Dornbusch, "but you have to start with growing the garden." If Bill Clinton picks up on their ideas, economists may get a chance to prove they can help cultivate a healthier economy in the 1990s.Karen Pennar and Christopher Farrell in New York