The U.S. Economy: Better Than You Thought
It's about time. For years, we've been arguing that America's economic numbers don't add up. The record stock market signaled a boffo economy, with fat corporate profits boosting share prices. Yet the 2.5% average growth rate of the '90s seemed subpar. Unemployment was down, but real wages weren't going up. Technology pervaded the workplace, but productivity gains remained lower than in the '60s. Hmm. The numbers just didn't make sense.
Now we know why. The Boskin Commission confirms what we long suspected: The economy has been a lot better than government statistics revealed. The commission, led by Michael J. Boskin, a Stanford University economist and George Bush's head of the Council of Economic Advisers, reports that the inflation rate is really 1.1 percentage points lower than the official consumer price index rate of 3%. The policy implications of this revision are profound.
Begin with the obvious: entitlements. Cost-of-living adjustments were introduced into Social Security and other government transfer programs to protect people's income against the ravages of inflation. Today, the 60 million or so people receiving government payments are clearly being overpaid. Cutting the COLAs by 1 percentage point saves about $90 billion over five years. To Republicans and Democrats sitting down to negotiate a budget-balancing deal, this is a godsend--but only if Congress and the President have the political will to withstand the lobbying by the American Association of Retired Persons and other interest groups.
The Federal Reserve is already doing the right thing. Chairman Alan Greenspan has been running monetary policy by Boskin-like numbers for some time now. He deserves kudos for withstanding pressure from inflation hawks who wanted to hike interest rates this past spring and summer. Greenspan and the Fed now must decide whether they have achieved price stability and what policy to pursue from here on out. If inflation is between 1% and 2%, should the central bank try to drive it down to zero? Or should it declare victory and act to keep prices on a steady keel for the future? William J. McDonough, head of the New York Federal Reserve, believes that the current low inflation rate provides just enough price fluidity to maximize growth. We agree. Let's accept the price stability indicated by the Boskin numbers and move on to monetary policies that sustain it.
What about implications for tax policy? The lower inflation figure means that real incomes have been rising, not stagnating. Recent anxieties now appear to have been caused by the uncertainties of an America painfully transforming itself into a global, information-based economy, not by a stagnant standard of living. The rise in real wages may explain, in part, why voters didn't grab at the 15% supply-side tax cut offered in the election. As incomes rise, pressure for tax cuts drops.
The report does fail to answer important questions about the relationship between inflation and growth. Research indicating that inflation is overstated also suggests that economic growth is understated. In the U.S., the index used to correct the market value of gross domestic product for inflation is the GDP deflator, which is also overstated. How much? Perhaps 0.5 percentage point, which means that real GDP is at least that much higher. Other evidence suggests GDP growth may be understated by as much as a full point.
The Boskin report didn't address whether the overstatement of inflation has been increasing. The commission assumes that the overstatement has been steady at 1.1 percent points for two decades. Yet the U.S. has become a high-tech, knowledge-based economy in that time. If the shape of the economy has changed, then the amount of overstatement of inflation may well be much larger in the '90s than the '70s, suggesting there could be more potential for growth. Until we get better statistical measures, we won't know for sure.
Two years ago, BUSINESS WEEK ran a Cover Story entitled "The real truth about the economy: How government statistics are misleading us." The good news is that things are a lot better than anyone thought. The bad news is that we still don't know exactly what's really going on in the economy. It's about time we did.