<DOC>
[109 Senate Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:30343.wais]
S. Hrg. 109-790
THE ECONOMIC REPORT OF THE PRESIDENT
=======================================================================
HEARING
before the
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
FEBRUARY 16, 2006
__________
Printed for the use of the Joint Economic Committee
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
HOUSE OF REPRESENTATIVES SENATE
Jim Saxton, New Jersey, Chairman Robert F. Bennett, Utah, Vice
Paul Ryan, Wisconsin Chairman
Phil English, Pennsylvania Sam Brownback, Kansas
Ron Paul, Texas John E. Sununu, New Hampshire
Kevin Brady, Texas Jim DeMint, South Carolina
Thaddeus G. McCotter, Michigan Jeff Sessions, Alabama
Carolyn B. Maloney, New York John Cornyn, Texas
Maurice D. Hinchey, New York Jack Reed, Rhode Island
Loretta Sanchez, California Edward M. Kennedy, Massachusetts
Elijah E. Cummings, Maryland Paul S. Sarbanes, Maryland
Jeff Bingaman, New Mexico
Christopher J. Frenze, Executive Director
Chad Stone, Minority Staff Director
C O N T E N T S
----------
Opening Statement of Members
Statement of Hon. Robert F. Bennett, Vice Chairman, a U.S.
Senator from Utah.............................................. 1
Statement of Hon. Carolyn B. Maloney, a U.S. Representative from
New York....................................................... 3
Witnesses
Joint statement of Dr. Matthew Slaughter and Dr. Katherine
Baicker, Members, Council of Economic Advisers................. 4
Submissions for the Record
Prepared statement of Representative Jim Saxton, Chairman........ 22
Prepared statement of Senator Robert F. Bennett, Vice Chairman... 23
Together with editorials from the Washington Post entitled:
``The End of Europe''.................................... 23
``The Fears Under Our Prosperity''....................... 24
Prepared statement of Senator Jack Reed, Ranking Minority Member. 26
Bar chart, submitted by Representative Carolyn B. Maloney,
entitled, ``The Bush Economy: The Distribution of Earnings Has
Become More Unequal,'' Bureau of Labor Statistics, Department
of Labor....................................................... 28
Prepared joint statement of Dr. Matthew Slaughter and Dr.
Katherine Baicker, Members, Council of Economic Advisers....... 29
THE ECONOMIC REPORT OF THE PRESIDENT
----------
THURSDAY, FEBRUARY 16, 2006
Congress of the United States,
Joint Economic Committee,
Washington, DC
The Committee met, pursuant to call, at 10:40 a.m. in room
2322, Rayburn House Office Building, the Honorable Robert F.
Bennett, Vice Chairman of the Committee, presiding.
Representatives present: Representatives Maloney, Paul, and
Cummings.
Senator present: Senator Bennett.
Staff present: Chris Frenze, Nan Gibson, Colleen Healy,
Brian Higginbotham, Bob Keleher, John Kachtik, Frank
Sammartino, Jeff Schlagenhauf, Chad Stone, Rachel Thomson, and
Katie Jones.
OPENING STATEMENT OF HON. ROBERT F. BENNETT,
VICE CHAIRMAN, A U.S. SENATOR FROM UTAH
Vice Chairman Bennett. The Committee will come to order. I
am here for Chairman Saxton, who will be here later. I
appreciate the indulgence of our witnesses and those who have
been here on time. The Senate has just conducted a vote, and I
had to be there to help save the Republic before I came to
these particular hearings. Why are you all laughing?
Today, the Committee will hear testimony from two of the
members of the President's Council of Economic Advisers. They
will be discussing the recently released Economic Report of the
President, which is appropriate. The Council of Economic
Advisers and this Committee were created by the same piece of
legislation as to get economic advice into the Executive Branch
and then provide a forum for economic discussions in the
Legislative Branch. So we welcome you in this one legislatively
sanctioned activity that we engage in.
Now, the President has nominated Dr. Edward Lazear of
Stanford University to serve as the chairman of the Council of
Economic Advisers. We had his confirmation hearing in the
Senate Banking Committee earlier this week. When he is
confirmed by the Senate, he will replace Dr. Ben Bernanke, who
has been in the news with other assignments. We heard from him
in the Congress yesterday as the new chairman of the Board of
Governors of the Federal Reserve.
But we are pleased to welcome the Council's other two
members, Dr. Kathleen Baicker--is that close enough?----
Dr. Baicker. Close enough.
Senator Bennett [continuing].--close enough--and Dr.
Matthew Slaughter to the Committee.
Now, as we look at the Economic Report of the President, we
do so against the backdrop of a strong and growing economy
which created 2 million new jobs over the past 12 months and
more than 4.7 million new jobs since August of 2003. Core
inflation remains relatively contained, and interest rates are
historically low despite recent increases by the Federal
Reserve.
That does not mean that the economy does not face
significant challenges in the future. Energy prices remain a
concern, and, of course, the uncertainties of the global
economy are always with us, and we face serious long-term
fiscal challenges tied to the retirement of the baby boomers
and the entitlement programs that have served us well in the
past but that are threatened by demographic changes.
I found it interesting that in this morning's paper there
was an op-ed piece by Robert Samuelson that posed a very
interesting question, which is, how can the economy be doing so
well and people feel so insecure and industries, like Ford and
General Motors, be in trouble while the entire economy has
performed better over the last 20-25 years than it ever has in
a similar period in our history. His answer is competition,
that the power of competition has made individual industries
and, therefore, their employees feel more uneasy about their
economic status even as it has improved the overall economic
well-being of the Nation as a whole. It is an interesting
thesis, and I would like to get into that with you as we go
into the question period.
[The Washington Post editorial entitled, ``The Fears Under
Our Prosperity,'' appears in the Submissions for the Record on
page 24.]
It is imperative that the Congress and the Administration
work together to handle these challenges head on. We have to
deal with entitlement spending. I have watched politicians, for
the dozen years I have been here, all tell me, yes, Senator, we
have to deal with that, and we will address it right after the
election because both sides want to carry the election rhetoric
to see if they can win just one more election on the past
rhetoric, and then they will tackle the tough problems, and as
we keep putting them off, the tough problems keep getting
tougher.
We all recognize the challenges that are essential for a
strong economy: improving our education system, not the direct
responsibility of this Committee but something we have to pay
attention to; the issue that Robert Samuelson raises of
international competitiveness; and we are finally recognizing
that our present tax system, born in the 1930s, is no longer
adequate to the challenges of a global economy in the 21st
century, and at least among some of my colleagues in the
Senate, we are beginning to have conversations about that.
So I look forward to hearing our witnesses describe how the
system, particularly the tax system, can be replaced, not
altered, not tinkered with, not ``reformed,'' but I think we
ought to start conversations about replacing it. Maybe you are
not prepared to do that today, but I am giving you the warning
that that is at least something that I am concerned with, and I
understand, having had conversations with your new chairman,
that he has an interest in that subject, too. That is a very
great understatement.
So we welcome you both to the Committee and look forward to
your testimony. Mrs. Maloney, there being no ranking member
present, why do not you assume that responsibility and give the
opening statement from that perspective?
[The prepared statement of Vice Chairman Bennett appears in
the Submissions for the Record on page 23.]
OPENING STATEMENT OF HON. CAROLYN B. MALONEY,
A U.S. REPRESENTATIVE FROM NEW YORK
Representative Maloney. Thank you very much, Chairman
Bennett. I have appreciated your thoughtful comments today and
always your sincere dedication to understanding and moving
forward the American economy in a stronger position.
Unfortunately, Senator Reed is not here right now. He will
possibly be here later, and I request that his statement be in
the record. Apparently, he is questioning Chairman Bernanke
right now, the Financial Services Committee.
[The prepared statement of Senator Reed appears in the
Submissions for the Record on page 26.]
Vice Chairman Bennett. Senator Reed has the same conflict I
do, and that is where I will flee as soon as Chairman Saxton
shows up, to go sit down with Mr. Bernanke and see if he is
easier to understand than Chairman Greenspan.
Representative Maloney. He is, and he actually answers
questions. I am shocked. I think he is great. He is a former
teacher, and it shows.
I want to particularly welcome our two panelists, Dr.
Baicker and Dr. Slaughter and mention that I am always
delighted when competent women are appointed to policy
positions. We are far underrepresented in our Government and in
many industries in our country. I want to welcome our male
friends, too.
The statute that created both the Council of Economic
Advisers and the Joint Economic Committee mandates that the
Joint Economic Committee should review the Economic Report of
the President, and I am pleased that you are here today to
discuss this truly important report for every American.
In its 11 chapters, this year's report covers a broad range
of topics and reflects the talent and professionalism of you
and the other economists on the CEA staff, but what concerns me
is the disconnect between the policies that the Bush
administration has been pursuing for the past five years and
the policies that can be justified by sound economic analysis.
I hope that you would agree that persistent, large budget
deficits and debts are not conducive to long-term growth and
our standard of living.
I hope you would also agree that even if there is not a
lockstep relationship between budget deficits and international
imbalances, it cannot be good for our national savings and our
trade deficit when the Federal budget moves from a substantial
surplus in 2000 to an even larger deficit in 2004, especially
when our personal savings rate has fallen and is now a
negative. Nor can it be good for our economy or our society
when workers are not seeing the benefits of economic growth in
their paychecks, and the gap between the haves and the have-
nots is widening. I think this is a trend that every Republican
and Democrat is deeply concerned about because that is a very
bad trend for, I would say, the economic well-being and the
spirit of America.
Your report wisely avoids trying to justify the President's
budget and tax policies, but I think it is important that we
try to understand what is really happening in the U.S. economy
and how the President's policies are affecting the economic
well-being of all Americans.
Foreign governments, as pointed out in the Financial
Services Committee yesterday, are buying GSEs--Government-
sponsored entities--instead of Treasury notes. In fact, they
now hold a third of our debt. What they are buying now, a third
of it is now GSEs, and I am concerned. Is that a warning sign
that we are getting near the edge, that foreign governments may
not continue to buy our debt at the rate that is needed to
sustain our spending?
I am also concerned, since this is a shift that I have
never seen before--possibly it has happened before, but I am
not aware of it--where GSEs have become a major holding of our
debt, and that, as you know, is a Government-private
sponsorship that is moving to the private away from Government.
What is the ramification, if any, on our economy?
I welcome you today. I congratulate you on your
appointments. Some very good people have come out of the
positions that you hold and have continued to lead and play
important roles in our Government. I thank you for your service
today and your service and commitment to our Government. Thank
you.
Vice Chairman Bennett. Thank you very much. We will now
hear from our panelists. Which one goes first?
Dr. Slaughter. I believe I shall.
Vice Chairman Bennett. Okay. Dr. Slaughter, and then we
will hear from Dr. Baicker.
JOINT STATEMENT OF DR. MATTHEW SLAUGHTER AND
DR. KATHERINE BAICKER, MEMBERS, COUNCIL OF
ECONOMIC ADVISERS
Dr. Slaughter. Thank you. Vice Chairman Bennett and other
members of the Joint Economic Committee, we are very pleased to
testify today about the 2006 Economic Report of the President.
The report reviews the state of the economy and the economic
outlook, and it discusses a number of economic policy issues of
continuing importance. Across its 11 chapters, the report
highlights how economics can inform the design of better public
policy and reviews Administration initiatives.
The performance of the U.S. economy continues to be strong.
In 2005, the Nation's real GDP grew 3.5 percent for the year,
above the historical average. Key components of demand that
accounted for growth in 2004--consumer spending, business
investment in equipment and software, and exports--continued to
do so in 2005. Employment increased by about 2 million payroll
jobs for the year, and the unemployment rate dropped to 4.7
percent last month, well below the averages of recent decades.
Real disposable personal income increased, and real household
net worth reached an all-time high. This growth comes on top of
an already strong expansion, the foundation of which has been
exceptionally rapid productivity growth. The Administration's
forecast, consistent with consensus private forecasts, shows
the economic expansion continuing for the foreseeable future.
Increases in investment spurred by the dividends and
capital gains tax relief enacted in 2003 have played an
important role in the strengthening of our economy. Since the
Jobs and Growth bill became law, capital investment has
increased by 25 percent, contributing to sustained job growth
and directly benefiting workers in the broader economy. It is
essential that this tax relief be extended.
American productivity growth, and thus competitiveness, in
the 21st century will rely upon American ingenuity,
entrepreneurship, and labor force talent. The President's
American Competitiveness Initiative aims to support these
forces. Promoting a flexible and skilled workforce through
improved access to high-quality primary, secondary, and post-
secondary education, through policies that attract the world's
best and brightest to our shores, and through investment in
research and development and the continuing education and
retraining of our mobile labor force will help ensure that the
United States remains a leader in this rapidly changing world
economy.
But maintaining this leadership will also require a
continued commitment to competition in and flexibility of U.S.
product, capital, and labor markets that help transform
innovations into the new products and processes in the
marketplace that ultimately support rising incomes for workers
and their families. Innovation alone is not sufficient to
guarantee rising prosperity. It also requires the dynamism of
the marketplace, for which America is uniquely positioned.
This continuing strength and competitiveness of the
American economy in the global marketplace depends upon
policies that open international markets to U.S. goods and that
promote growth and investment at home. The performance of the
U.S. economy depends on an effective financial services sector
and on a tax system that promotes domestic growth and
international competitiveness.
Further opening of foreign markets to U.S. goods would
yield great rewards for Americans. Over the past 70 years,
policymakers across political parties have consistently
recognized the importance of international commerce and have
achieved major trade liberalization both here and abroad. The
net payoff to America from these achievements has been
substantial.
The Administration's policies will make even greater gains
possible. Support of the agricultural sector can be provided in
ways that are less distortionary. We must work to eliminate
further barriers to trade, especially in services, and to
further open markets in global, regional, and bilateral
negotiations. Americans will reap the greatest benefits from
this trade when intellectual property rights are well defined
and well enforced. The Administration continues to enforce
vigorously the laws that protect the rights of American
intellectual property owners.
Dr. Baicker. The continued expansion of energy markets and
diversification of energy sources can further increase our
resilience to energy supply disruptions. Hurricanes Katrina and
Rita demonstrated that competitive markets play a central role
in allocating scarce energy resources, especially during times
of natural disaster or national emergency. Policies that build
on economic incentives and that spur our development of
alternative fuel sources can further reduce U.S. vulnerability
to energy disruptions and dependence on foreign oil, encourage
energy efficiency, and protect the environment.
Even as living standards rise, Americans are increasingly
concerned about their retirement security and health care
costs. Most working-age Americans are, in fact, on track to
save as much as most retirees, but there are a number of risks
to the retirement preparations of Americans. People today are
living longer and can face higher health care costs in
retirement than members of previous generations. In addition,
both defined-benefit pension plans and Social Security suffer
from fundamental financial problems that expose not just
retirees but all U.S. taxpayers to risk of substantial losses.
The Administration is focused on addressing these problems and
protecting the Nation's retirement security.
Rising health care costs are of concern to all Americans,
young and old. All Americans deserve access to reliable,
affordable, high-quality, high-value health care. Health care
in the United States is second to none, but it can be better.
Both public and private health care spending have grown much
more rapidly than general inflation or wages, straining
consumers, employers, and Government budgets. The cost of
finding new health insurance locks some workers into their
current jobs if they or someone in their family is ill or in
less-than-perfect health. Frivolous lawsuits can raise health
care costs for everyone. Perverse tax and insurance incentives
have led to inefficient use of our health care resources.
Promoting a stronger role for consumers can help create a
health care system that is more affordable, more transparent,
more portable, and more efficient. Health savings accounts
should be strengthened by allowing people to contribute enough
to them to pay for all of their out-of-pocket expenditures tax
free. Individual purchasers should have the same tax advantages
as those who get insurance from their employers. We need to
ensure that patients and their doctors have the information
they need to use this control to get the health care that is
best for them and that electronic health records are widely
used to reduce costs and to improve the quality of medical
treatment.
The report provides an analytical backdrop for the
President's agenda, which includes restraining Government
spending, making tax relief permanent, making health care more
affordable and accessible, creating an economic environment
that encourages innovation and entrepreneurship, continuing to
open markets to American goods and services, and reducing
America's dependence on foreign oil by diversifying our energy
supply. These policies will help maintain the economy's
momentum, foster job creation, and ensure that America remains
a leader in the global economy.
Thank you all for this opportunity to discuss the 2006
Economic Report of the President, and we would be happy to
answer any questions you might have.
[The prepared joint statement of Dr. Slaughter and Dr.
Baicker appears in the Submissions for the Record on page 29.]
Vice Chairman Bennett. Thank you very much. We appreciate
your testimony and the hard work that went into the creation of
the report. You have touched on a number of issues that I find
fascinating, and let me just explore a few of them with you.
The Samuelson column and the comments you have made
demonstrate how changed this economy is from the one that I
grew up in and, indeed, the one that many people thought was
normal. ``Normal'' meant you graduated from high school or
college, and you got a job. You went to work at Sears & Roebuck
as a stock boy, and then you became a salesman on the floor,
and then you became a standpoint manager, and if you were
really good, you got to be an assistant store manager, and at
the end of your career, you had been a store manager, and you
got your pension and a gold watch, and life was good.
If you graduated and went to work at Ford or Delphi or one
of the giant companies, the unions negotiated on your behalf.
Your wages were not only stable, but they rose with virtually
every negotiation in both real terms as well as with respect to
inflation. Your job may not have been all that stimulating, but
you stayed on the manufacturing line, you did a good job, you
were there for 40 years, and you retired with or without the
gold watch but with a pension and lifetime health benefits.
That world is gone, and it is never coming back, however
much we in the Congress might want to legislate its return. The
world in which we now live is a world of intense competition,
and the emphasis is on the word ``world,'' a world of intense
competition, and those who meet the competitive challenge
thrive, and those who do not are almost ruthlessly left behind.
I just came back, a few weeks ago, from a trip to the Far
East, and we went to China, and the Chinese are very concerned
about losing jobs to Vietnam, and, interestingly enough, the
Chinese are worried about intellectual property rights because
as their economy matures, and they begin to invent things of
their own, they get very upset when somebody in some other
country steals their patents without protecting their
intellectual property rights. It was very interesting to hear
Chinese officials say, we have to have tough international
intellectual property right regulations, to which we could only
say, hooray, we are glad you finally got the message.
When we did go to Vietnam, the people in Vietnam said, ``Do
not look to China as the place to go; look to us.'' And in both
cases they said, ``We do not want an economy built on cheap
labor. We are making sure that our economy is built on
technological breakthroughs and high quality.'' That is not the
image you get reading the op-ed pages of the New York Times,
but that is the image that you get when you get out into the
world.
I think Samuelson is exactly right: People are doing better
than they have ever done before, and they are more uneasy and
feel more threatened than they ever have before, and I am not
sure his analysis that that is due to competition is the right
one, but that is certainly probably the place to start. However
much we might want to not live in such a competitive world, the
fact is we are there, and there is nothing we can do about it
except accept it, compete, and be the ones that survive.
I wish I had brought it with me. Again, a recent piece
pointed out that Europe is almost in a death spiral and that
the average European, within 15 to 20 years, will be half as
wealthy as the average American because they are not
competitive, they have tried to hang onto the model that I have
described as the past as their view of the future, and the net
result has been to say that Europe is dropping out of the
global competition, and the countries that will survive and
thrive in the future will be the United States, China, and
India, and I am not so sure that China will, given their
population problems and the demographic challenges they have.
[The Washington Post editorial entitled, ``The End of
Europe,'' appears in the Submissions for the Record on page
23.]
They were talking to us about the difficulties of what they
call the ``one-two-four pyramid.'' They will have one worker,
because of their one-child program, who will have to support
two parents and four grandparents, and they have no safety net
of the kind that we take for granted in that society. So the
parents are looking to their child to support them, but the
grandparents are still alive, and the economic burden of the
one-two-four pyramid in China is something we can be grateful
we do not face.
All right. I apologize. I am making a speech here, and I
should be asking a question, so let me do the standard
senatorial thing. What do you think?
Dr. Slaughter. I believe the answer is yes. I will offer a
few reactions to that, if I may, Senator. You raise an
excellent set of points.
There is a famous labor economist named Richard Freeman who
refers to the change in the nature of the global economy in the
past 15 years. He has coined the phrase ``the great doubling.''
If you take the populations of China and India and the former
Soviet Union and many eastern European countries, that is about
half of the world's population, and if we go back even just 15
years, that set of countries economically was effectively sort
of on the moon. They were very isolated and not part of the
global economic system.
So one of the things that is very different today from the
past when we think about global integration, if we go back,
say, 10 to 15 years ago in the United States, there was a lot
of discussion about the implications and ramifications of the
North American Free Trade Agreement and extending our free
trade agreement with Canada, to include Mexico. Candidly,
Mexico is sort of rounding error when you are trying to get a
hold on the number of people effectively that are now part of
the population with the great doubling that we have
experienced.
So that is something that is qualitatively different, and
during that period the sense of unease that Robert Samuelson
has talked about, he is correct. If you look at public opinion
surveys on people, how they view the nature of their labor
market attachment, for about 15 years now throughout the United
States and also in many other countries you see rising self-
reports of worker uncertainty and worker unease. That speaks to
the fact that the nature of labor market attachment for people,
it just does not depend on their earnings; it depends on the
reliability of those earnings. There are many dimensions of
labor force attachment that people think about.
In the United States, as I alluded to in my comments, we
have been enjoying this productivity acceleration that started
in 1995 and that has continued even further since the year
2000, which is wonderful from the standpoint of average living
standards in the United States because productivity growth is
the only sustainable foundation for rising average living
standards for America.
One of the notable features about this productivity
acceleration, especially since the year 2000, has been the
critical role played by what economists call ``total factor
productivity growth,'' not the growth of capital per worker but
sort of the organization and the innovations that combine
workers with their capital in terms of what products firms are
going to make and how they are going to make it. There is now
substantial evidence from academic research, from the business
community research, that the force of competition, especially
international competition, is an important spur to productivity
growth for firms and, therefore, for countries as a whole, and
that is just based on a lot of empirical studies of lots of
industries around the world. One example that I will give is
retail trade.
So one of the important industries that has contributed to
the productivity growth in the United States in the past
several years has been the retail trade sector. The United
States has had a very different experience from many
continental European countries like you cite. We have had a lot
of innovations in retail trade that have been implemented
thanks to competition and flexible capital and labor markets in
the United States.
So Wal-Mart, Costco, Target, those types of firms, have
been able to establish and expand new types of retailing
services in the United States, very different from in Europe
where they have made a different set of choices, where there
are much more qualitative and quantitative restrictions on land
use, labor market use, and capital market turnover that have
inhibited the ability of retailers to replicate the kind of
performance we have seen in the United States.
So I broadly agree with what Robert Samuelson is talking
about, that the forces of competition are very important for
contributing to rising living standards in the United States,
but that competition has certain dimensions to it, and, again,
one of them is thinking about what is the distribution of the
overall productivity gains and the sense of certainty or
uncertainty that that imparts to different segments of the
workforce.
Dr. Baicker. To build on what Dr. Slaughter discussed about
the uncertainties that workers face in the modern economy,
technology is evolving much more quickly, and the labor market
is changing much more quickly than it had in the past, as you
said, so it is especially important that we provide the support
that workers need to move from shrinking sectors of the economy
to growing sectors of the economy, whether those changes are
generated by trade or internal development of new technologies,
or by changing tastes in the marketplace.
Any source of displacement for workers necessitates that
they get additional training and that they have the support
that they need to get that training and income support during
the time when they are transitioning between jobs. That is an
important component to ensure that everyone in the economy can
benefit from overall economic growth.
To build on that as well, you mentioned retirement security
of workers who expect a lifetime pension, and one of the
important supports for retirement security is that pension
promises are kept. Through the defined-benefit pension system,
workers were promised a stream of income in their retirement.
It is important that we make sure the incentives are in place
and the regulatory oversight is in place that those promises to
those workers are kept to them so they can feel more secure
about their retirement security as they move from job to job.
Vice Chairman Bennett. Thank you. I will not monopolize. I
have got a lot of reactions to what you have had to say, but
just one quick one. As we go into this new world, I think we
need to get the mentality that pensions and health care are no
longer tied to the employer but to the employee so that the
employee who accrues pension benefits working for his first job
takes those with him to his second job and this third and his
fourth and his fifth and so on.
It is now very clear that people will normally and
routinely in their lifetimes have 10 jobs at 10 different
places and sometimes change fields entirely. A veterinarian may
end up as a stockbroker or vice versa. If you can accumulate
and bring with you your pension benefits, which is what the
401(K) program is supposed to do, and do the same thing with
health care, you own your health care benefit rather than your
employer so there is no concern about a preexisting condition
because it is your plan, and you take it with you and
ultimately control it.
We are not used to thinking like that. We are so tied to
the old paradigm--we keep trying to keep the old paradigm alive
because it worked for so many years--that we are actually
putting ourselves ultimately in the position of jeopardizing
what has to be done for our children and our grandchildren.
Mrs. Maloney?
Representative Maloney. Thank you so much for your
statement, all of you. It gives all of us a great deal to think
about.
I would like to go back to one of the areas that I
mentioned in my opening statement, and that is the growing
divide between the haves and the have-nots in this country.
Last fall, we had a Democratic forum on the economy where one
economist, Alan Blinder, gave some very interesting testimony
on this topic, and he argued that there had been a long-term
trend toward greater inequality interrupted for a short while
in the late 1990s. He did not use this particular chart, but I
think it illustrates how we are all on the wrong track on this
particular issue.
The blue bars show the usual weekly earnings of full-time
wage and salary workers at different points in the earnings
distribution between 1995 and 2000, a time of great economic
growth, and the red bars show the same thing between 2000 and
2005. You see that during the Clinton years, the divide between
the poorest people and the richest people was just a little
over one percentage point, where now the divide between the
poorest and the richest is now a clear six points. That is a
growing inequality that I find disturbing.
[The bar chart entitled, ``The Bush Economy: The
Distribution of Earnings Has Become More Unequal,'' appears in
the Submissions for the Record on page 28.]
Professor Blinder went on to argue that it was market
forces, rather than Government policy, that is the major source
of earnings inequality. That is what he argued. I just want to
understand what is different about these market forces in the
1990s compared with now.
Do you agree with him that it is market forces, not
Government policies, that lead to this inequality? If so, what
is different now than before? Some people argue that inequality
is present because we have cut some spending on domestic
programs. He argued that that was not the point. He said it was
market forces causing this. Could you elaborate and further
explain your take on this to me and to others?
Dr. Slaughter. Sure. I will offer some initial comments on
that and turn it over to Dr. Baicker.
I broadly agree with Dr. Blinder's assessment of rising
income inequality in the United States.
Representative Maloney. Do you agree that it is market
forces, not Government policy?
Dr. Slaughter. Yes.
Representative Maloney. I am sorry. I have to hand it back
to him and read your statements in the published record. I am
sorry. I have to go vote, first responsibility. We have got to
vote. Okay.
Vice Chairman Bennett. We are going to have a lot of fun
without anybody from the House to monitor us.
Representative Maloney. I do not think you need to be
monitored. I wish I was here to hear what you have to say,
quite frankly.
Vice Chairman Bennett. Thank you.
Representative Maloney. I want to add to what you have to
say, and this is just an observation. I am going to miss a vote
on this. I am amazed at New York's economy after 9/11. I just
thought we would never recover because of the devastation. We
blew out so many jobs and I have to tell you that practically
everyone I meet tells me they lost their job. Yet our economy
has rebounded, so it must have rebounded with new jobs, which
illustrates what you are saying--this tremendous, dynamic
change. It is really amazing, practically everyone I talk to
tells me they lost their job. How can unemployment be worse
than the rest of the country? But it is still not that bad in
New York even when everybody I talk to says they lost their
job. It is amazing. I would like to hear your comments on that,
too.
Vice Chairman Bennett. Okay. Go back to the chart and
comment on it.
Dr. Slaughter. Sure.
Vice Chairman Bennett. I think that is a legitimate issue
she has raised.
Dr. Slaughter. Absolutely. They definitely are. So there
are two features of that chart that I will highlight and expand
on. One is that on most measures income equality in the United
States across skills has been rising since the late 1970s, so
the red bars there are more reflective of what the U.S. economy
has been experiencing since, as I said, the late 1970s.
So one of the features of the U.S. economy that has been
quite different in the past generation from previous
generations is the distribution of gains. It has not been the
rising tide lifting all boats. There has been something going
on, and this, again, is in pretax earnings. There are some
changes in the nature of supply and demand in the U.S. labor
market that have been raising the returns to skills, in
particular. There are other dimensions of income inequality
that have been rising as well. What economists call ``within-
group inequality'' has been increasing as well.
But if you focus on the returns to skills and different
parts of the income distribution that are shown in that figure,
the late 1990s that are shown there are actually the exception
rather than the rule for how the U.S. labor market has been
performing for quite some time. That is one fact I will
highlight.
The other is that one of the striking features is that this
is not a uniquely U.S. phenomenon. Most other countries around
the world over the same time period of the past generation have
also been experiencing rising income inequality. So the U.K.
and many continental European countries; there sometimes the
inequality has been manifested more in rising unemployment for
less-skilled workers, even countries where you might think
opposite trends would be expected, so middle-income countries
like Mexico. Even today we see in China and India substantial
evidence of rising income inequality as well.
A substantial amount of academic research has looked at
this question, and the preponderance of evidence and
conclusions from researchers has been that the main force
driving up the returns to skills and contributing to the rising
inequality has, again, been technology innovations that tend to
favor the demand for skills.
So it sort of comes back to some of the issues we were
talking about before, which is that we have got these
technology innovations that firms are implementing that raise
the need for more-skilled workers and, as the figure shows,
raise the returns to more-skilled workers, and that speaks to
the broad policy challenge of how do we try to ensure that as
many Americans as possible have the kinds of skills that firms
are increasingly demanding in the workplace.
Dr. Baicker. To elaborate on those points, the returns to
education have been going up over time, and it is especially
important, then, to ensure that all children have access to
high-quality education through primary and secondary school and
that people have the financial resources to continue their
education beyond secondary school, such as through the
expansion of grants to community colleges that
disproportionately train people in growth industries. So
ensuring access to those educational institutions is
particularly important in the modern economy.
One other point I would like to make is that those bars
would look a little bit different if you took out the full
income of those different groups. So the earned income tax
credit has been an important component of increasing the
resources available to people at the low end of the income
distribution. It has been a very successful program in both
giving people income stability and the resources that they need
and also in promoting participation in the labor force.
So while the point that income inequality has been rising
is well taken and true, it is important to also consider the
total bundle of resources available to people across the income
distribution.
Vice Chairman Bennett. Thank you. Is there any parallel
with the fact that from 1995 to 2000--the recession started in
2000, or the downturn started in 2000, the last quarter--those
were five years of expansion and growth. The recession hit in
2001. How can 2000 be 11.1 and minus 2.1? You have got 2000 up
there twice. Oh, this is fourth quarter to fourth quarter.
Okay. Well, then that shows that the recession started in the
fourth quarter of 2000 with the minus 2.1.
Does that impact the visual message coming off the chart,
the fact that you have got five years of expansion and three
years of the recession and the slow recovery? The recovery
really did not begin to take hold until 2003, so is that a
factor here, or is that just coincidence?
Dr. Baicker. That is a very important point, and I thank
you for making it. It highlights the fact that a growing
economy is a prerequisite for everyone in the economy to do
better, and so policies that encourage economic growth will
help people at all points in the income distribution.
Dr. Slaughter. That is right. I believe, if I remember the
statistics correctly, by the peak that is in around 2000, the
aggregate unemployment rate in the United States briefly dipped
below 4 percent to about 3.9 percent. So the strength in the
labor market overall is a force that does tend to help pull up
the incomes of everyone, including those at the lower end.
Vice Chairman Bennett. Yes. Okay. But your overall
conversation says that the real source of the income gap is a
skill gap. Is that an acceptable statement, or is that too
simplistic?
Dr. Baicker. It is an important component.
Vice Chairman Bennett. Okay. It is an important component.
That is an economist's way of saying, you are not quite right,
Senator. How big a component is it? You are an economist; put a
number on it. Is the skill gap 50 percent of the problem, 70
percent of the problem?
Dr. Slaughter. Again, there has been this ongoing secular
increase in demand for more-skilled workers relative to less-
skilled workers. I think if you took a look at the body of
research evidence here, the majority of that shift in demand
for skills gets attributed to the technology innovations that
favor skilled workers.
Other forces that have been looked at that seem to have
played some role but a much smaller role include freer
international trade and immigration inflows also. So some
dimensions of greater international commerce and global
engagement have played a role, it appears, in shifting demand
in the United States towards more-skilled workers, but it
played a relatively small role compared to these technology
innovations.
Vice Chairman Bennett. So we have got a skill gap, we have
got the impact of international trade, we have got the impact
of technology, and we have got the question of whether we are
in a growth period or a recessionary period, and all of those
play into it. Okay.
Dr. Slaughter. Correct.
Vice Chairman Bennett. Okay. Mrs. Maloney raised another
issue that I would like to explore with you. She talked about
the savings rate. We now have a negative savings rate. As I
have looked at that, we had a savings rate in the United States
that was fairly stable and then started to tip downward in the
1980s and has continued downward on a very even trajectory
since the 1980s to the point that it finally turned negative.
It did not turn down and flatten out; it just started down in
the 1980s and has kept going down in the 1980s.
So this is not a phenomenon of the last five years or the
last 10 years; it is the last quarter century that we have been
dealing with a falling savings rate. Talk about that. Tell me
why that is the case.
Dr. Slaughter. So the decline in personal household savings
rates that you mention has been another long-term feature of
the U.S. economy. The report discusses that trend and looks at
some of the possible reasons behind it.
One of the reasons that has been contributing to it,
especially in recent years, that the report talks about is it
kind of looks at the overall financial picture of households
and points out that one of the positive features of
productivity growth and the aggregate income gains over time
has been rising household wealth. So net worth of households in
terms of the assets they own minus the liabilities such as home
mortgages; that has been rising, especially in recent years,
with increases in equity prices and, more recently, home
prices.
Vice Chairman Bennett. Have the two gone in lockstep, the
savings down and the housing, over 25 years?
Dr. Slaughter. Not as much over 25 years, in part, I think,
because the increases in household net worth have been more
noticeable in recent years. A lot of research has shown that
when households have increases in their wealth, they tend to
take some of that wealth in terms of higher consumption, and so
the report looks at some analysis that says, given what we know
about the propensity of households to increase their
consumption when they have more wealth, especially in recent
years as household net worth has increased quite well, that
explains some of the decline of the overall national personal
savings rate.
The other broad feature of savings I would mention is, as
Mrs. Maloney had correctly pointed out, when we think about
savings for the United States in a global context, an important
source of savings for the U.S. economy overall to finance
investment of firms in recent years has been foreign savings.
So we have domestic savings, which consists of savings by
households, there is savings by the Government, there is
savings by companies, and then to the extent that we have open
borders, we also can use some of the savings of the rest of the
world.
So the economic report talks in detail about how our
current account deficit reflects the fact that on net, in
recent years, the United States has been using some foreign
savings to finance the investment by our companies.
Vice Chairman Bennett. That brings up the other subject
that she mentioned in her opening statement about foreign
investors buying paper from the GSEs. Do you want to comment on
the comment that she made in that regard?
Dr. Slaughter. Sure. The data are correct. I do not know
the exact details offhand, but GSEs are one of the assets that
foreign private investors and public investors have been
purchasing, but it speaks to the point that when we look at the
range of assets that the rest of the world is purchasing from
the United States in recent years, it is a pretty broad
portfolio, actually. So the range of assets that are tracked in
our statistics that we have in the United States include
Treasury securities, and they include the GSE bonds. They also
include corporate bonds, corporate equities, bank loans, and
another major component of that investment is foreign direct
investment, so companies with an ownership statement.
When we look at the data that are collected by the Treasury
Department and also by the Bureau of Economic Analysis, the
distribution of all of the assets on net that are owned by the
rest of the world is pretty evenly distributed actually across
those different classes of assets.
So foreign investors, both public and private, are thinking
about what is the right mix of assets to own, and over time I
think it is reasonable to expect there to be some evolution in
the composition of the net foreign debt position of the United
States.
Vice Chairman Bennett. So they are not necessarily
targeting GSEs as a preferred investment; they are simply
diversifying their investments and say we can do a little of
this and a little of that.
Dr. Slaughter. I think that is right. On net, when you look
at, again, the total stock of U.S. assets that are owned by the
rest of the world, again, I do not have the exact statistics in
front of me, but it is distributed pretty smoothly across those
different asset classes. There is no one class, for example,
that I listed that constitutes over 50 percent of the total
assets that are owned.
Vice Chairman Bennett. There is not a disparate preference
for GSE over Treasury?
Dr. Slaughter. I would have to look at the changes over
time in recent years. Offhand, sir, I do not know the exact
changes in the distribution of Treasury securities versus GSEs.
I would need to look at those data in particular. I just do not
have them handy.
Vice Chairman Bennett. It is my impression that there is
not, that the appetite for Treasuries remains as strong as it
has ever been.
Dr. Slaughter. That very well may be.
Vice Chairman Bennett. But I cannot prove it, so I will not
claim it.
Dr. Slaughter. We need the statistics.
Vice Chairman Bennett. Okay. I am sure someone would raise
the issue of the trade deficit. Every time we had Chairman
Greenspan before us, he would say that the trade deficit in the
short-term is not a problem and in the long-term is
unsustainable, so you got a headline either way, depending on
how you felt about it. Talk to us about the trade deficit,
short-term and long-term----
Dr. Slaughter. Absolutely.
Chairman Bennett [continuing]. And what we can do about it.
Dr. Slaughter. Sure. The report has substantial discussion
on the trade deficit. The facts as we know is that the trade
deficit has been rising, so the recent data for 2005, the trade
deficit for the United States with the rest of the world in
goods and services came in at about $726 billion. A better
metric is the share of GDP. It is a share of 5.8 percent of
GDP.
Vice Chairman Bennett. What is the breakdown between goods
and services?
Dr. Slaughter. We actually run a surplus with the rest of
the world in services.
Vice Chairman Bennett. That was my sense because many times
the newspapers focus on the goods trade deficit and say the sky
is falling, and they do not understand that we are recovering
some of that with services.
Dr. Slaughter. That is correct, sir. So for 2005, our trade
surplus in services with the rest of the world was a little
over $56 billion. That increased from the previous year, and it
comes back to some of the issues you raised earlier. There is
more change in the global economy, and part of that means a lot
more activities that used to not be tradable now can be traded
across borders, like business-processing services that we hear
a lot of anecdotes about recently. That increases the
possibility for U.S. companies, which tend to be quite good at
a lot of service activities, which reflects the fact that over
80 percent of jobs in the U.S. economy are in the service
sector. That raises the potential for more export opportunities
for U.S.-based companies. So we run a bigger trade deficit in
goods, then, that leads to the total trade deficit.
So the rise in the trade deficit that has been ongoing is
definitely a source of concern, and thinking about the
underlying causes and possible transitions going forward is
very important, I think. We know that some of the features of
the strength of the U.S. economy in recent years account for
the rising trade deficit. One, in particular, is the fact that
we have had much faster economic growth that we have been
discussing than have most of our major trading partners.
So about two-thirds of our trade is still with other high-
income advanced countries, such as Japan, Germany, and France,
and they have been growing at much slower rates than has the
United States, which means our faster growth rates and faster
income growth tend to mean we are importing a rising amount of
their goods and services compared to how much of our exports
they are taking in with their income growth. That said, some of
the forces that account for the increases in the trade deficit
are more worrisome, and you correctly point out that the
ongoing decline in personal household savings is one of those.
Going forward, then, we can think about different market-
based and policy-based adjustments in the rest of the world and
in the United States that would contribute to a moderation in
the global imbalances that we see in the world today. In the
United States, raising national savings relative to investment
would be changes that would contribute to an amelioration of
the trade deficit, so that would be savings by households
perhaps. Again, that is a difficult issue, given that we have
seen household savings falling for some time. One of the broad
motivations for the tax reform panel was to think about putting
in place a different set of incentives that might stimulate
savings.
For the rest of the world, I think policy challenges
include things like trying to undertake policy reforms that
would stimulate faster economic growth that would contribute to
more exports from the United States going to those countries if
they were enjoying faster growth.
Vice Chairman Bennett. Well, let us look into our crystal
ball and say Europe is not going to grow. Japan, aging economy,
shrinking population. They do not encourage immigration. India
and China, yes, they are growing at dramatic rates, but they
are still not major sources for American exports.
Dr. Slaughter. Right.
Vice Chairman Bennett. How do you turn this around?
Dr. Slaughter. That is an excellent question to which I do
not have the perfect crystal ball.
Vice Chairman Bennett. All right. What happens if we do
not?
Dr. Slaughter. I would say two things. One is you are
correct to point out that both China and India have been
growing quite quickly. Of our major trading partners, our
exports to China have been growing faster than any other
country, over 20 percent per year in the past five years.
So one of the broad forces that we can hope for is faster
economic growth and productivity growth, in particular, in
China and India that will raise average incomes there and allow
them to have the earning power to purchase more goods and
services from the United States.
For Europe and Japan, you are absolutely correct, sir, that
the growth challenges there are, at some level, daunting, given
the underlying demographics that are going to limit the
population and labor force growth and given that, again, in
recent years, at least, they have not enjoyed the kind of
productivity performance that the United States' economy has.
In the near term, at least, there are signs of strengthening
both business and consumer sentiment in Japan and in Germany,
in particular. So for those two countries, which are two of our
largest trading partners, if capital investment and
productivity growth could strengthen, those would be forces
that would lead to greater trade between the United States and
those countries.
Going out, then, it will remain to be seen what other
sources of growth there might be abroad and then what sorts of
adjustments, again, both from a policy standpoint and from a
market-based standpoint, of what firms and households choose to
do around the world to see the distribution of U.S. trade and
the total amount of U.S. trade with the rest of the world.
Vice Chairman Bennett. You have not answered my question
about looking out. Say that things do not change dramatically.
Okay. Europe gets a little stronger here and there, but over
the next 30 years, things do not change, and the trade deficit
just continues to grow every year, not every year, but the
trend line continues to go up every year for the next 30 years.
What does that mean to us at that point? Is there a day of
reckoning out there, or can we go on like this indefinitely?
Dr. Slaughter. Again, that is an excellent question. As the
report talks about, the companion of the trade deficit in goods
and services that we run is this surplus in trade in assets. So
another way to think about the question going forward is to
what extent will the rest of the world continue to be willing
to purchase more and more U.S. assets. To the extent that there
is a shift in demand away from U.S. assets towards other
countries' assets, either from private actors or public actors,
that will be a force that will slow the rate of growth, if not
start to bring down the global imbalances that we see today.
What we would see in the marketplace, in part, might be a
change in the market prices of currencies and also of interest
rates as well.
But, again, one of the broad puzzles, I think, that we are
not quite sure about how it will play out, is that the
imbalances that we have seen arise in recent years are
qualitatively different from the ones we have seen in previous
decades and generations in part because many countries around
the world have relaxed policy restrictions on the flows of
capital across borders, and so we are now in an environment
with a much greater degree of capital mobility across borders
than we had in earlier times, and the underlying economics.
We know, kind of like trade in goods and services, that
when we liberalize, there should be imbalances across borders,
and so one of the challenges for policymakers, for researchers,
for the business community going forward is trying to ascertain
to what extent now this sort of new environment with greater
capital mobility, what degree of imbalances might be
sustainable.
Vice Chairman Bennett. You are not drawing a doomsday
scenario. You are basically describing a readjustment and a
soft landing. As long as the U.S. economy remains strong, we do
not worry about the trade deficit?
Dr. Slaughter. No. We continue to worry about the trade
deficit, absolutely.
Vice Chairman Bennett. But you have not given me, and I do
not think there is, any prescription of what to do about it. As
long as we remain stronger than other people, and our economy
is growing faster, we are going to run a trade deficit. We do
not want to slow us down just for the sake of statistically
getting rid of the trade deficit.
Dr. Slaughter. Correct.
Vice Chairman Bennett. But what is the problem? What will
be the consequence, long-term, as these adjustments occur? Will
the U.S. economy slow down? Will there be greater income
imbalance? What will be the consequences?
Dr. Slaughter. That is the excellent and correct question
to ask. Again, it is going to be a mix of changes in the United
States and changes in the rest of the world in terms of the
balance of the United States on net having much higher
investment than the pool of national savings, and the converse
holds in many of our many trading partners like Japan and
Germany. So those countries, for example, have seen sharp
declines in their investment rates in recent years relative to
their savings.
So, again, I could foresee a number of different scenarios
in which there is greater capital investment in countries like
Japan and Germany, as I talked about, related to their savings,
which would mean that they would run smaller trade surpluses.
In the United States, then, some mix of greater national
savings related to our investment would be the offsetting
change. Again, how quickly that happens and the kind and extent
of adjustment of prices of currencies and interest rates
depends; there is just a number of different scenarios that one
could envision there.
It is hoped for that the adjustment would not be sudden and
dramatic, the kind of hard landing that you are referring to.
Instead, it is hoped for that, given market flexibility that we
have been discussing, that the adjustment would be more gradual
over a longer period of time.
Vice Chairman Bennett. Well, we have been here an hour, and
I have taken up almost all of it with my questions and your
answers, which, for me, is just great, but it looks as if our
House colleagues will not be returning, and I have run out of
things to ask in their behalf. So thank you very much for being
here, and the Committee is adjourned.
Dr. Slaughter. Thank you.
Dr. Baicker. Thank you.
[Whereupon, at 11:37 a.m., the Committee was adjourned.]
Submissions for the Record
=======================================================================
[GRAPHIC] [TIFF OMITTED] T0343.004
Prepared Statement of Senator Robert F. Bennett, Vice Chairman
Today, the Committee will hear testimony from two members of the
President's Council of Economic Advisors relative to the recently
released Economic Report of the President. As members of the Committee
are aware, the President has nominated Dr. Edward P. Lazear of Stanford
University to serve as Chairman of the Council of Economic Advisors.
When confirmed by the Senate, Dr. Lazear will replace Dr. Ben Bernanke
who was recently confirmed as the new Chairman of the Board of
Governors of the Federal Reserve. We are pleased, however, to welcome
the Council's two other members, Dr. Katherine Baicker and Dr. Matthew
J. Slaughter to the Committee.
As we examine the Economic Report of the President, we do so
against the backdrop of a strong and growing economy. The economy has
created two million new jobs over the past twelve months and more than
4.7 million new jobs since August 2003. Core inflation remains
relatively contained. Interest rates remain historically low despite
recent increases by the Federal Reserve.
This does not mean that our economy does not face significant
challenges in the future. We are faced with high energy prices and ever
increasing competition in an increasingly global economy. Additionally,
we face serious long term fiscal challenges as a result of promises
made in entitlement programs and the demographic reality of an aging
population.
It is imperative that Congress and the Administration work together
to meet these and other challenges head on. We must work to reign in
entitlement spending. We must work together to improve our educational
system. We must improve our competitiveness in the global economy. And
we must reform a tax system that is overly complex and highly
inefficient if we hope to compete effectively in the future.
I believe this is of particular importance and I look forward to
hearing our witnesses describe how that system can best be replaced--
yes replaced--not simply altered. The time has come to start with a
clean sheet of paper and the novel concept that the purpose of the tax
system is to raise money to run the government and not to engineer
society. We need a system built on three straightforward principles--it
must be simple, it must be efficient, and it must be competitive.
Again, welcome to the Committee. We look forward to your testimony.
______
[From the Washington Post, June 15, 2005]
The End of Europe
(By Robert J. Samuelson)
Europe as we know it is slowly going out of business. Since French
and Dutch voters rejected the proposed constitution of the European
Union, we've heard countless theories as to why: the unreality of
trying to forge 25 E.U. countries into a United States of Europe; fear
of ceding excessive power to Brussels, the E.U. capital; and an
irrational backlash against globalization. Whatever their truth, these
theories miss a larger reality: Unless Europe reverses two trends--low
birthrates and meager economic growth--it faces a bleak future of
rising domestic discontent and falling global power. Actually,
thatfuture has already arrived.
Ever since 1498, after Vasco da Gama rounded the Cape of Good Hope
and opened trade to the Far East, Europe has shaped global history, for
good and ill. It settled North and South America, invented modern
science, led the Industrial Revolution, oversaw the slave trade,
created huge colonial empires, and unleashed the world's two most
destructive wars. This pivotal Europe is now vanishing--and not merely
because it's overshadowed by Asia and the United States.
It's hard to be a great power if your population is shriveling.
Europe's birthrates have dropped well below the replacement rate of 2.1
children for each woman of childbearing age. For Western Europe as a
whole, the rate is 1.5. It's 1.4 in Germany and 1.3 in Italy. In a
century--if these rates continue--there won't be many Germans in
Germany or Italians in Italy. Even assuming some increase in birthrates
and continued immigration, Western Europe's population grows
dramatically grayer, projects the U.S. CensusBureau. Now about one-
sixth of the population is 65 and older. By 2030 that would be one-
fourth, and by 2050 almost one-third.
No one knows how well modern economies will perform with so many
elderly people, heavily dependent on government benefits (read: higher
taxes). But Europe's economy is already faltering. In the 1970s annual
growth for the 12 countries now using the euro averaged almost 3
percent; from 2001 to 2004 the annual average was 1.2 percent. In 1974
those countries had unemployment of 2.4 percent; in 2004 the rate was
8.9 percent. Wherever they look, Western Europeans feel their way of
life threatened. One solution to low birthrates is higher immigration.
But many Europeans don't like the immigrants they have--often Muslim
from North Africa--and don't want more. One way to revive economic
growth would be to reduce social benefits, taxes and regulations. But
that would imperil Europe's ``social model,'' which supposedly blends
capitalism's efficiency and socialism's compassion.
Consider some contrasts with the United States, as reported by the
Organization for Economic Cooperation and Development. With high
unemployment benefits, almost half of Western Europe's jobless have
been out of work a year or more; the U.S. figure is about 12 percent.
Or take early retirement. In 2003 about 60 percent of Americans ages 55
to 64 had jobs. The comparable figures for France, Italy and Germany
were 37 percent, 30 percent and 39 percent. The truth is that Europeans
like early retirement, high jobless benefits and long vacations.
The trouble is that so much benevolence requires a strong economy,
while the sources of all this benevolence--high taxes, stiff
regulations--weaken the economy. With aging populations, the
contradictions will only thicken. Indeed, some scholarly research
suggests that high old-age benefits partly explain low birthrates. With
the state paying for old age, who needs children as caregivers? High
taxes may also deter young couples from assuming the added costs of
children.
You can raise two objections to this sort of analysis. First, other
countries are also aging and face problems similar to Europe's. True.
But the aging is more pronounced in Europe and a few other nations
(Japan, for instance), precisely because birthrates are so low. The
U.S. birthrate, for example, is 2.1; even removing births to Hispanic
Americans, it's about 1.9, reports Nicholas Eberstadt of the American
Enterprise Institute. Second, Europeans could do something about their
predicament. Also, true--they could, but they're not. A few countries
(Britain, Ireland, the Netherlands) have acted, and there are
differences between Eastern and Western Europe. But in general Europe
is immobilized by its problems. This is the classic dilemma of
democracy: Too many people benefit from the status quo to change it;
but the status quo isn't sustainable. Even modest efforts in France and
Germany to curb social benefits have triggered backlashes. Many
Europeans----maybe most--live in a state of delusion. Believing things
should continue as before, they see almost any change as menacing. In
reality, the new E.U. constitution wasn't radical; neither adoption nor
rejection would much alter everyday life. But it symbolized change and
thereby became a lightning rod for many sources of discontent (over
immigration in Holland, poor economic growth in France).
All this is bad for Europe--and the United States. A weak European
economy is one reason that the world economy is shaky and so dependent
on American growth. Preoccupied with divisions at home, Europe is
history's has-been. It isn't a strong American ally, not simply because
it disagrees with some U.S. policies but also because it doesn't want
to make the commitments required of a strong ally. Unwilling to address
their genuine problems, Europeans become more reflexively critical of
America. This gives the impression that they're active on the world
stage, even as they're quietly acquiescing in their own decline.
______
[From the Washington Post, Feb. 16, 2006]
The Fears Under Our Prosperity
(By Robert J. Samuelson)
A puzzle of our time is why the economy has become increasingly
stable while individual industries have become increasingly unstable.
The continuing turmoil at General Motors and Ford simply reflects this
more pervasive industrial instability--also in airlines,
telecommunications, pharmaceuticals and the mass media, among others.
Hardly a week passes without layoffs from some major company, which is
``downsizing,'' ``restructuring'' or ``outsourcing.'' And yet, the
broader economy has undeniably become more stable. Since the early
1980s, we've had only two recessions, lasting a combined year and four
months and involving peak unemployment of 7.8 percent. By contrast,
from 1969 to 1982, we had four recessions lasting altogether about four
years and having unemployment as high as 10.8 percent.
A cottage industry of economists is cranking out studies on these
questions. One intriguing theory--completely counterintuitive--is that
the greater overall stability stems in part from the increased
instability of individual industries. You would, of course, expect the
opposite: As individual industries became less stable, so would the
larger economy.
But the reality may be more complex. Different industries may go
through cycles that are disconnected from each other, argue economists
Diego Comin and Thomas Philippon of New York University. All don't rise
and fall simultaneously. To simplify slightly: Housing, autos and
farming might strengthen, while computers, airlines and chemicals
weaken.
Assuming there's something to this theory--which seems a good bet--
it helps explain the riddle of why there's so much anxiety amid so much
prosperity. As Americans stock up on BlackBerrys and flat-panel TVs,
it's hard to deny the affluence. But people also look to their
employers for a sense of confidence about the future--and here doubts
have multiplied, because more companies and industries seem assailed by
menacing forces. We can all identify the usual suspects. Globalization.
Deregulation. Greater domestic competition. In a series of papers,
Comin, Philippon and various colleagues have shown that, for most
businesses, sales, profits and employment have all become more volatile
in recent decades. They bounce around more from year to year,
suggesting greater industry instability. Competitive pressures have
dramatically intensified. One telling statistic: In 1980 a firm in the
top fifth of its industry had about a 1-in-10 chance of losing that
position within a five-year period; by 1998 the odds had increased to 1
in 4. Feeling threatened, corporate managers have altered pay and
employment practices. In 1994, economists Peter Gottschalk of Boston
College and Robert Moffitt of Johns Hopkins University showed that
annual wage gains also had begun to bounce around more in the 1980s (in
technical lingo, there was more variation around the average). Now,
Comin and Erica Groshen of the Federal Reserve Bank of New York and
Bess Rabin of Watson Wyatt Worldwide have connected these erratic wage
increases to firms' fluctuating fortunes. In good years, companies
enlarge the pot for wage and salaries, says Groshen; in bad years, the
pot grows less or shrinks. About four-fifths of big U.S. firms also
resort more to bonuses, personal incentives and stock options, Hewitt
Associatesreports.
The same sort of cost-conscious behavior also leads to more
layoffs, even among career workers. In 1983, 58 percent of men ages 45
to 49 had been with their current employer 10 years or more, reports
the Bureau of Labor Statistics. By 2004, the comparable figure was 48
percent. Little wonder that we have rising job insecurity, despite
lower average unemployment.
Not by accident do many of these trends begin, or strengthen, in
the 1980s. From 1980 to 1983, the Federal Reserve crushed inflation,
which fell from 12.5 percent to 3.8 percent. Inflation dulls
competition. Sloppy managers can simply raise prices. Because most
companies are rapidly increasing prices, customers have a harder time
discriminating. Inflation also comes to dominate the business cycle. It
overwhelms other influences. Once inflation declined, competition--
based on prices, new products and technologies--intensified.
Differences among sectors became more pronounced. So we return to the
original puzzle: Why does an economy of greater stability have
industries of lesser stability? The answer is competition. An intensely
competitive economy enhances overall stability by holding down
inflation (which is itself destabilizing) and spreading economic
disruptions throughout the business cycle (rather than letting them
accumulate for periodic, massive downturns). But the solution to one
problem creates other, though smaller, problems. Except during
unsustainable booms, say, the late 1990s, even good times are
punctuated with insecurities, disappointments, job losses, broken
promises and shattered expectations. What may be good for us as a
society may hurt many of us as individuals. The unending challenge is
to find the necessary social protections that help the most vulnerable
without frustrating desirable, if sometimes painful, change.
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Prepared Joint Statement of Dr. Matthew Slaughter and Dr. Katherine
Baicker, Members, Council of Economic Advisers
Chairman Saxton, Vice-Chairman Bennett, Ranking Member Reed, and
other members of the Joint Economic Committee, we are pleased to
testify today about the 2006 Economic Report of the President. The
Report reviews the state of the economy and the economic outlook, and
discusses a number of economic policy issues of continuing importance.
Across its 11 chapters, the Report highlights how economics can inform
the design of better public policy and reviews Administration
initiatives.
The performance of the U.S. economy continues to be strong. In
2005, the Nation's real GDP grew 3.5 percent for the year, above the
historical average. Key components of demand that accounted for growth
in 2004--consumer spending, business investment in equipment and
software, and exports--continued to do so in 2005. Employment increased
by almost 2 million payroll jobs over the year, and the unemployment
rate dropped to 4.7 percent last month, well below the averages of
recent decades. Real disposable personal income increased, and real
household net worth reached an all-time high. This growth comes on top
of an already strong expansion, the foundation of which has been
exceptionally rapid productivity growth. The Administration's forecast,
consistent with consensus private forecasts, shows the economic
expansion continuing for the foreseeable future.
Increases in investment spurred by the dividends and capital gains
tax relief enacted in 2003 have played an important role in the
strengthening of our economy. Since the Jobs and Growth bill became
law, capital investment has increased by 25 percent, contributing to
sustained job growth and directly benefiting workers. It is essential
that this tax relief be extended.
American productivity growth and thus competitiveness in the 21st
century will rely upon American ingenuity, entrepreneurship, and labor-
force talent. The President's American Competitiveness Initiative aims
to support these forces. Promoting a flexible and skilled workforce--
through improved access to high-quality primary, secondary, and post-
secondary education, through policies that attract the world's best and
brightest to our shores, and through investment in R&D and the
continuing education and re-training of our mobile workforce--will help
ensure that the United States remains a leader in this rapidly changing
world economy.
But maintaining this leadership will also require a continued
commitment to competition in and flexibility of U.S. product, capital,
and labor markets that help transform innovations into the new products
and processes in the marketplace that ultimately support rising incomes
for workers and their families. Innovation alone is not sufficient to
guarantee rising prosperity. It also requires the dynamism of the
marketplace for which America is uniquely positioned.
This continuing strength and competitiveness of the American
economy in the global marketplace depends upon policies that open
international markets to U.S. goods, and that promote growth and
investment at home. The performance of the U.S. economy depends on an
effective financial-services sector and on a tax system that promotes
domestic growth and international competitiveness. Further opening
foreign markets to U.S. goods would yield great rewards for Americans.
Over the past 70 years, policymakers across political parties have
consistently recognized the importance of international commerce, and
have achieved major trade liberalization both here and abroad. The net
payoff to America from these achievements has been substantial.
The Administration's policies will make even greater gains
possible. Support of the agricultural sector can be provided in ways
that are less distortionary. We must work to eliminate further barriers
to trade, especially in services, and to further open markets in
global, regional, and bilateral negotiations. Americans will reap the
greatest benefits from this trade when intellectual property rights are
well-defined and well-enforced. The Administration continues to enforce
vigorously the laws that protect the rights of American intellectual-
property owners.
The continued expansion of energy markets and diversification of
energy sources can further increase our resilience to energy-supply
disruptions. Hurricanes Katrina and Rita demonstrated that competitive
markets play a central role in allocating scarce energy resources,
especially during times of natural disaster or national emergency.
Policies that build on economic incentives and that spur our
development of alternate fuel sources can reduce U.S. vulnerability to
energy disruptions and reliance on foreign oil, encourage energy
efficiency, and protect the environment.
Even as living standards rise, Americans are increasingly concerned
about their retirement security and health care costs. Most working-age
Americans are in fact on track to have more retirement wealth than most
current retirees. There are, however, a number of risks to the
retirement preparations of Americans. People today are living longer
and could face higher health-care costs in retirement than members of
previous generations. In addition, both defined benefit pensions and
Social Security suffer from fundamental financial problems that expose
not just retirees but all U.S. taxpayers to risk of substantial losses.
The Administration is focused on addressing these problems and
protecting the Nation's retirement security.
Rising health care costs are of concern to all Americans, young and
old. All Americans deserve access to reliable, affordable, high-
quality, high-value health care. Health care in the United States is
second to none, but it can be better. Both public and private health
care spending have grown much more rapidly than general inflation or
wages, straining consumers, employers, and government budgets. The cost
of finding new health insurance locks some workers into their current
jobs if they or someone in their family is chronically ill. Frivolous
lawsuits raise health care costs for everyone. Perverse tax and
insurance incentives have led to inefficient use of health care
resources.
Promoting a stronger role for consumers can help create a health
care system that is more affordable, transparent, portable, and
efficient. Health Savings Accounts should be strengthened by allowing
people to contribute enough to them to pay for all of their out of
pocket expenditures tax free. Individual purchasers should have the
same tax advantages as those who get insurance from their employers. We
need to ensure that patients and their doctors have the information
that they need to use this control to get the health care that is best
for them, and that electronic health records are widely used to reduce
costs and improve the quality of medical treatment.
The Report provides an analytical backdrop for the President's
agenda, which includes restraining government spending; making tax
relief permanent; making health care more affordable and accessible;
creating an economic environment that encourages innovation and
entrepreneurship; continuing to open markets to American goods and
services; and reducing America's dependence on foreign oil by
diversifying our energy supply. These policies will help maintain the
economy's momentum, foster job creation, and ensure that America
remains a leader of the global economy.
We will briefly outline for you the highlights of the Report.
Chapter 1, The Year in Review and the Years Ahead, reviews the economic
developments of 2005 and discusses the Administration's forecast for
the years ahead. The expansion of the U.S. economy continued for the
fourth consecutive year in 2005, with strong growth in real GDP. Most
components of demand that accounted for growth in 2004--consumer
spending, business investment in equipment and software, and exports--
continued to do so in 2005. Labor markets continued to strengthen, with
almost 2 million new jobs created in 2005 and a year-end unemployment
rate of 4.9 percent. Productivity growth remained well above its
historical average. Overall inflation rose substantially at mid-year,
but came down by year-end as it reflected the movement of energy
prices, while core inflation (which excludes food and energy prices)
has remained in the moderate 2-percent range. The Administration's
forecast, consistent with consensus private forecasts, shows the
economic expansion continuing for the foreseeable future.
Chapter 2, Skills for the U.S. Workforce, discusses the economics
of education, immigration, and job training. Promoting a flexible and
skilled labor force--through improved access to high quality primary,
secondary, and post-secondary education, through policies that attract
the world's best and brightest to our shores, and through investment in
the continuing education and training of our mobile workforce--will
ensure that the United States remains a competitive leader in this
rapidly changing world economy.
Chapter 3, Saving for Retirement, addresses the concern that
Americans have been preparing inadequately for retirement. Most
working-age Americans are in fact on track to have more retirement
wealth than most current retirees. There are, however, a number of
risks to the retirement preparations of Americans. People today are
living longer and could face higher health-care costs in retirement
than members of previous generations. In addition, both defined benefit
pensions and Social Security suffer from fundamental financial problems
that expose not just retirees but all U.S. taxpayers to risk of
substantial losses. The Administration is focused on addressing these
problems and protecting the Nation's retirement security.
Chapter 4, Improving Incentives in Health Care Spending, reviews
the causes and consequences of health care spending growth and
discusses how the President's consumer-driven proposals can improve the
health care system. Growth in spending on health care has been much
more rapid than general inflation, straining consumers, employers, and
government budgets. Perverse tax and insurance incentives have led to
inefficient levels and composition of spending on health care.
Promoting a stronger role for consumers is a promising strategy for
improving health care value and affordability.
Chapter 5, The U.S. Tax System in International Perspective,
examines U.S. tax system choices in the context of other countries.
These choices matter because they affect living standards and economic
growth. The United States has a different tax structure from most other
advanced economies, raising more of our revenue through a tax on
personal income instead of consumption. While the U.S. system has been
significantly improved in recent years, it could benefit greatly from
additional reforms, particularly those focused on the taxation of
capital income.
Chapter 6, The U.S. Capital Account Surplus, discusses the enormous
number of trade and financial transactions the U.S. has with other
countries. In 2004, the United States ran a current account deficit of
$668 billion--meaning that the United States imported more goods and
services than it exported, and that foreign investors purchased more
U.S. assets than U.S. investors purchased in foreign assets. The size
and persistence of U.S. net capital inflows reflect a number of U.S.
economic strengths, as well as some shortcomings. Greater global
balance of capital flows can be promoted by higher domestic savings,
better growth and investment opportunities in Europe and Japan, and
greater exchange rate flexibility and financial sector reforms in Asia.
Chapter 7, The History and Future of International Trade, notes
that while economic research and historical evidence show that the
benefits of trade outweigh the costs, trade liberalization has always
generated concerns in the United States and throughout the world. Over
the past 70 years, policymakers across political parties have
consistently recognized the importance of international commerce, and
have achieved major trade liberalization both here and abroad. The net
payoff to America from these achievements has been substantial. The
Administration is working to eliminate further barriers to trade,
especially in services, and to further open markets in global,
regional, and bilateral negotiations.
Chapter 8, The U.S. Agricultural Sector, examines the effects of
agricultural support payments and trade policy on domestic prices, the
wellbeing of the agricultural sector, and of the economy overall. In
2005, the Federal Government spent approximately $20 billion on
agricultural support payments, but most farmers do not benefit from
these subsidies. In addition, the United States maintains barriers to
the import of some commodities, and these barriers raise the domestic
prices of these commodities relative to world prices. Support to
agriculture can be provided in many forms that are potentially less
market-distorting.
Chapter 9, The U.S. Financial Services Sector, explores what
financial services do for an economy, how financial development relates
to economic performance, and how financial services can be effectively
regulated. The U.S. financial services sector improves economic
performance by addressing informational problems and facilitating
innovation. An effective financial regulatory system appropriately
balances the costs and benefits of public regulation.
Chapter 10, The Role of Intellectual Property in the Economy, notes
that intellectual property rights create incentives for investment in
research, development, and innovation. Well-defined and enforced
intellectual property rights are an important element of the American
economy and can contribute to the economic growth of all countries. The
Administration continues to enforcevigorously the laws that protect the
rights of American intellectual property owners.
Chapter 11, Recent Developments in Energy, discusses crude oil,
refined petroleum products, natural gas, and electricity markets.
Increased scarcity and rising prices over time will encourage
conservation, increase incentives for exploration, and stimulate the
development of new, energy efficient technologies and alternative
energy sources. In the near term, unexpected disruptions to energy
supply and distribution networks may continue to affect consumers and
businesses. Hurricanes Katrina and Rita demonstrated that competitive
markets play a central role in allocating scarce energy resources,
especially during times of natural disaster or national emergency. The
continued expansion of energy markets through regional and global trade
can further increase our resilience to energy supply disruptions.
Policies that build on economic incentives can reduce U.S.
vulnerability to energy disruptions, encourage energy efficiency, and
protect the environment.
Thank you for this opportunity to discuss the 2006 Economic Report
of the President. We would be happy to answer any questions you might
have.
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