It's easy to be nostalgic for the 1990-91 recession that gave way to the Clinton boom. What will it take to ignite that kind of growth today?
The U.S. economy remains almost comatose....The current slump already ranks as the longest period of sustained weakness since the Great Depression....Once-in-a-lifetime dislocations...will take years to work out. Among them: the job drought, the debt hangover, the defense-industry contraction, the [banking] collapse, the real estate depression, the health-care cost explosion and the runaway federal deficit.
That's how Time described the dismal state of the U.S. economy—in September 1992. The passage has been making the rounds in financial circles, a token reminder that to day's pessimism—the forecast of a "lost decade" for U.S. employment by Pimco CEO Mohamed El-Erian, for example—may turn out to be too extreme.
Almost before that Time article reached the recycling bin, the U.S. economy was humming again. Real gross domestic product rose 4.3 percent, both in the fourth quarter of 1992 and on a year-over-year basis—and for the rest of the decade America never looked back. The recession that officially ended in March 1991 lasted just eight months, one of the shortest U.S. downturns ever; it took another year to produce consistent job growth. Soon, however, the jobless recovery that helped elect Bill Clinton in 1992 ushered in a decade of prosperity, with 23 million new jobs created. By the spring of 1997, unemployment had fallen below 5 percent—a 24-year low—yet inflation was holding steady at around 3 percent, with consumer confidence near an eight-year high. No wonder Clinton was beginning a second term.
Could it happen again? When it comes to financial markets, pessimism is a buy signal. Just when the outlook is bleakest, when investors have liquidated their stocks or sold them short, markets tend to turn up. Can the same be said about economic pessimism?
One should never underestimate America's capacity for self-renewal, its spirit in the face of adversity. The unexpected Clinton-era boom owed a lot to a technology-driven leap in productivity growth, which had slumped to about 1.5 percent from the mid-1970s to mid-1990s, then bounced back to 2.5 percent. Right now it's hard to see what might come along to goose U.S. productivity in the same way, but to quote Melanie Griffith's character in the George H.W. Bush-era movie Working Girl, "You never know where the next big idea might come from."
That said, there are good reasons to believe a 1990s-style surprise—strong job and economic growth—won't materialize in this decade. The foundations for growth that were in place then are missing now.
Take declining deficits. The end of the Cold War saw defense spending fall from 5.2 percent of GDP when Clinton took office to 3 percent in 2000. At the same time, the tech bubble of the last half of the 1990s and a capital-gains tax cut in 1997 produced a revenue windfall for the U.S. Treasury as investors took profits. Personal income taxes as a share of GDP rose to a record 10.2 percent in 2000 compared with a more typical 8 percent. The federal government posted its first budget surplus in almost three decades in 1998. It wasn't until 2002 that wars, tax cuts, recession, and a less ebullient stock market conspired to bring the deficit back with a vengeance.
Today federal coffers remain ravaged by the recession that started in December 2007. A combination of falling tax revenues—individual income taxes fell to a 60-year low of 6.2 percent of GDP—and soaring government spending produced a $1.45 trillion deficit last year. Fiscal 2010, which ends Sept. 30, is expected to show a marginal improvement in the deficit to $1.3 trillion, according to the Congressional Budget Office's August outlook.
The deficit hole comes just as the baby boomers are starting to retire. Life expectancy is increasing at the same time as the ratio of workers to retirees is falling.
The more resources devoted to keeping Gram and Gramps in the style to which they have become accustomed, the less there is to invest in the future: in new technologies that will raise productivity growth; in the education of our children to enable them to compete in a global workforce; and in plants and equipment that increase the economy's productive capacity. Without these investments—without a 1990s-like burst of productivity growth—the U.S. will find it hard to fulfill its promises to future generations and, at the same time, provide an environment that nurtures the entrepreneurs of the future.
There is one parallel between 2010 and the Clinton era. In political terms, this election year is shaping up to be a lot like 1994, when the Republicans wrested control of both houses of Congress from the Democrats. It was the first GOP majority in the House in 50 years.
In response, Clinton moved to the center, something that many business leaders would welcome from President Barack Obama. Rightly or wrongly, many blame the current confidence slump on Obama and the Democratic Congress. A fiscal policy in flux is not conducive to entrepreneurship.
America's challenges, however, go well beyond its political class. As a nation, we demand more in benefits than we're willing to pay for in taxes. If we aren't won't compromise, we'd better find a way to grow the pie.
One way would be real tax reform—scrapping the Internal Revenue Code and replacing it with something simpler and flatter. Forget targeted tax cuts, which simply create more opportunities for gaming and more business for lobbyists. Just think how much more productive businesses would be if they spent the same time and money on their products and services that they do on influence peddlers and lawyers.
U.S. businesses and households will devote over 7.5 billion hours this year to complying with income tax laws, according to the National Taxpayers Union's "A Taxing Trend" report for 2010. For individuals, the total compliance tab, including the value of their time and the cost of tax preparation, amounts to $103 billion.
"Given the huge amount of expense our overcomplicated tax system imposes on us, fundamental tax reform would be one of the best ways imaginable to stimulate our economy without plunging the country further into debt," writes David Keating, senior counselor at the Taxpayers Union. He advocates replacing the "current mess" with a flat tax or national retail sales tax. Congress, of course, is not about to relinquish its power over the tax code. America would need a national grassroots movement and perhaps a constitutional amendment to force through such a reform. That would be a worthy final act for the baby boomers—and it might help bring back the boom.