Commentary: Deficits? Class Warfare? No, It's About Growth

Forget the fight between Republicans and Democrats. When it comes to economic policy, what's going on now is a struggle between "growth optimists" on one side and "economic declinists" on the other.

Optimists, whether conservative or liberal, believe that the long-term growth potential of the U.S. remains bright. Sure, there's dispute about the best way to encourage growth. Conservatives favor lower taxes on capital; liberals support more funding for research and development and education. And technologists, regardless of their political stripe, want to encourage the innovative companies of Silicon Valley. But the optimists share a common goal: sustaining, or even beating, the strong economic performance of the 1990s.

By contrast, declinists--and there are plenty of them among both conservatives and liberals--think the 1990s boom was at best an anomaly, and at worst a bubble that did more harm than good. Such declinists preach the gospel of sacrifice and belt-tightening. They would rather hold down the federal budget deficit, instead of encouraging private investment through tax cuts or providing more funding for R&D and education. And because declinists think of the economy as relatively slow-growing, they worry more about how to divvy up the economic pie than how to make it bigger.

One of the most influential declinists is Paul Krugman, a Princeton economist and a high-profile New York Times columnist. Krugman has long been pessimistic about the U.S. economy's future, as shown by the title of his 1990 book, The Age of Diminished Expectations. In the mid-1990s, he vehemently objected to the New Economy idea that technology could boost the rate of productivity growth, writing that "there is no good reason to believe that the speed limit on the economy has been raised." At the same time, he argued that unemployment could not fall below 5.5% without triggering inflation.

On both counts, Krugman was wrong. Annual productivity growth has accelerated to an average 2.6% since 1995, up a full percentage point from the preceding two decades. And unemployment dropped below 4% while inflation stayed quiescent.

But it's one of Krugman's latest pieces that shows most clearly the difference between the optimistic and declinist perspectives. In his Jan. 21, 2003, column, Krugman takes on a BusinessWeek Cover Story titled "Class Warfare?" analyzing the growth impact of Bush's plan to eliminate the personal tax on dividends. Krugman said BusinessWeek didn't pay enough attention to "who gets what"--that is, income inequality.

But Krugman's focus on inequality, in part, reflects his skepticism about the ability to stimulate long-term growth. In the short run, Krugman argues for Keynesian measures, such as providing more aid for hard-pressed state governments. But in the long run, Krugman, like other declinists, seems fixated on controlling the budget deficit. Unfortunately, economic theory suggests that even eliminating the budget deficit will have a relatively small impact on the long-run growth rate.

More is needed. As BusinessWeek pointed out, the best thing for poor Americans is fast growth and low unemployment, even if it brings more inequality. That's the lesson of the 1990s, when the rich prospered but the poverty rate fell as well, going from 15% in 1993 to less than 12% in 2001. Over the same stretch, real wages for production and nonsupervisory workers rose by 10%--reversing a 20-year downward trend.

An economy should be judged, at least partly, by how well it treats the poor. By that measure, the 1990s were a success. No one can guarantee the Bush tax proposal is the best way to repeat this performance. But at least its focus on growth points in the right long-term direction. That's something skeptics like Krugman ignore.

By Michael J. Mandel

    Before it's here, it's on the Bloomberg Terminal.