FROM THE OFFICE OF PUBLIC AFFAIRS

It is a pleasure to join you today to discuss developments in the U.S. economy, the Administration’s economic policies, and the important role of international trade.

Current Developments in the U.S. Economy

In the Office of Economic Policy at the Treasury Department, my staff and I track a broad array of economic and financial data every day.  As a result of this scrutiny, I can tell you that economic fundamentals are sound and the U.S. economy is firmly established on an upward path.  Last week the Commerce Department reported that economic activity increased at a 7.2 percent annual rate in the third quarter.  While some slowdown from that elevated pace is to be expected, we, as well as private forecasters, expect strong expansion to continue through the fourth quarter and well beyond.

After growing at a rather sluggish pace late last year and early this year, positive signs of improvement began to build through the spring.  The swift expulsion of the regime of Saddam Hussein in Iraq lifted the consumer mood.  Attractive auto incentives and the extraction of home equity through a surge in mortgage refinancing also contributed to an acceleration of personal consumption expenditures in the second quarter.  Indicators of investment demand such as new orders and shipments of nondefense capital goods perked up as well, and the nascent recovery in real equipment and software investment resumed in the second quarter of 2003.  The firmer tone to investment and consumption helped raise real GDP growth to a 3.3 percent annual rate in the second quarter, more than double the pace of the prior two quarters.

The passage of the Jobs and Growth Tax Relief Reconciliation Act in May provided almost immediate additional support for the economy in the third quarter.  By July, withholding tables reflected reduced marginal tax rates on individual income, and the child tax credit checks began to be delivered to households.  This raised households’ cash flow and spurred consumer spending. 

 The increase in bonus depreciation and quadrupling of the expensing limit for small businesses encouraged business investment.
The impact was substantial.  Total consumer spending surged in the third quarter and equipment and software investment shot up at its fastest rate since the first quarter of 2000.  Production responded to the pickup in final demand in the last two quarters, and manufacturing output rose at almost a 3 percent annual rate in the third quarter after declines in the prior three quarters.

Many of the strengths that were evident going into the third quarter are likely to continue to provide support to the economy going forward.  Productivity growth has been exceptional, including very substantial gains in the past two quarters.  The 4.3 percent rate of increase since the fourth quarter of 2000 – a period that includes both recession and recovery – was the strongest of any eleven-quarter period in 40 years.  Higher productivity means higher real wages for workers and rising standards of living.

Businesses are beginning to reap the benefits of those productivity improvements.  Profits and cash flow are growing and unit costs have been held in check, paving the way for further gains in investment.  Small business optimism recently reached a record high level, according to the National Federation of Independent Business, and the Conference Board reported that confidence among large-company CEOs was the strongest in 11 years.  Improved business optimism is a first step in the revitalization of labor markets.

Equity prices have climbed about 30 percent since mid-March, improving financing conditions for business as well as adding to household net worth.  Boosted by the tax cuts, real disposable personal income is rising.  Household and business balance sheets benefited from low interest rates over the past few years, leaving those sectors in a good position to continue to spend.  Rates are still quite low and credit yield spreads are narrowing, enhancing prospects for investment.

The housing sector has been an engine of growth throughout the recession and recovery and the homeownership rate has risen to a record 68.2 percent.  Housing continued to expand through the third quarter and construction starts and permits point to further growth in residential investment ahead.  This view is supported by the highest level in four years of homebuilder optimism regarding the six-month outlook, according to the National Association of Home Builders.  Even with the recent rise in interest rates, more than 80 percent of consumers still think it is a good time to buy a home, according to the Michigan consumer sentiment survey.

Overseas economies appear to be improving and providing a growing market for U.S. exports, which surged more than 9 percent at an annual rate in real terms in the third quarter for the first quarterly gain in a year.  The October index of manufacturers’ orders for exports of the Institute for Supply Management suggests additional strength going forward.  Inventory rebuilding and the production that it stimulates should also contribute to growth.  Through the past few quarters inventories have been trimmed to very low levels as businesses met demand out of existing stockpiles.

That is expected to turn around with the revival of strong demand. Recent consensus forecasts expect real GDP growth to ease in the fourth quarter to 4.0 percent and roughly maintain that pace through next year.  That rate is above the estimated potential rate of growth of the economy, and the sustained trend above potential should lead to a pickup in employment.  In fact, the Labor Department announced today that the unemployment rate dipped from 6.1 percent in August and September to 6.0 percent in October.  Payroll employment rose by 126,000 and results for August and September were revised up substantially.  Today’s figures show that the economy created 286,000 jobs during the past three months, the best performance since before the recession.  More recent weekly unemployment insurance claims suggest further progress was made after the October employment survey was taken. 

The improvement in labor markets is already evident in Florida.  Although still somewhat elevated, Florida’s unemployment rate has eased from a recent peak of 5.8 percent in late 2001 and now stands at 5.2 percent – roughly a percentage point below the national average.  Florida has added jobs since the economy entered recession in early 2001.  Since January of that year, nonfarm payroll employment in the state has expanded by 176,000.  That is the biggest increase of any state over that period.

Professional forecasters expect that the acceleration in real growth in the third quarter and over the coming year will lead to a sizable increase in employment.  Estimates are converging on a job gain of about 2 million over the four quarters ending in the third quarter of 2004.

Though positive signs are emerging and the outlook is favorable, we have seen during the latest recession and recovery how sensitive labor markets have become compared to the experience of previous cycles.  It appears to be taking longer for labor markets to respond to an upturn in economic activity.  Since creating new jobs is a top priority of the Administration, in addition to the stimulus packages already at work, the President recently unveiled a six-point plan to reduce barriers and uncertainties that may be impeding businesses from hiring additional workers.  The plan includes a series of measures to help the economy operate more efficiently, such as tort reform, providing an affordable energy supply, streamlining regulation, making tax cuts permanent, improving the affordability of health care, and opening new markets for U.S. products.

U.S. and the Global Economy

 As all of you are well aware, opening new markets and increasing foreign demand for U.S. goods and services is a key factor in enhancing our continued domestic economic growth.  Both empirical work and recent trends suggest that the behavior of export markets has a far greater impact on manufacturing employment than import competition.  One study found that a 10 percent rise in overall sales due to exports is associated with a 7 percent increase in employment, while a similar rise in the import share of domestic sales is linked to a smaller 4 percent decline in employment. 

I probably don’t have to do too much explaining to this audience about the benefits of foreign trade, as Florida ranks as the eighth largest export-producing state in the nation and is the sixth largest recipient of foreign direct investment (FDI).  Foreign affiliates provided over 300,000 jobs to state residents in 2000 (latest available), ranking Florida fourth in the nation for FDI-related jobs.  Like the rest of the country, Florida’s merchandise exports dropped in 2002.  The decline was larger than the national loss in percentage terms, as the State’s key overseas markets, particularly those in Latin America, generally experienced greater deterioration in economic conditions.  The diverse array of export goods produced in Florida, however, along with its high value-added services exports such as consulting, legal, medical, and financial services, should serve Florida well in the international marketplace going forward.

I would now like to discuss the overall U.S. position in the world economy and the Administration’s efforts to enhance free trade and promote export growth.  The dimensions of total U.S. transactions with the rest of the world is typically measured by the current account.  The current account balance is equal to the difference between national saving and investment, and mainly reflects the balance of trade in goods and services, as well as net investment income and transfer payments.  Neither a deficit nor a surplus is inherently bad or good.  We would not be concerned with a current account deficit if investment growth was strong and well directed, increasing future economic growth that will be used to pay foreigners for the financing of that investment, and still leave us with something left over to enjoy in terms of an improved standard of living.  Similarly, we can expect foreign developed economies in general (especially Japan and Western Europe) to tend to lend to us more than we lend to them because their economies are aging faster than ours and because of the investment opportunities afforded by our high-productivity economy.

 Nevertheless, these trends can become worrisome and be overdone if the current account deficit is being used simply to finance increases in consumption with no prospect of repayment.  One sign of trouble would be an increase in domestic interest rates.  Flexibility of exchange rates is a good thing in general because it helps the economy adjust to market forces, and allows the monetary authority to focus on macroeconomic conditions (in the short run) and price stability (in the long run), rather than trying to manage the exchange rate.

 Recently our economic growth has improved greatly and we are seeing an acceleration in investment (aided by fiscal policy measures that increased depreciation write-offs for business equipment).  This has led to an increase in the current account deficit, to an annual rate of $554.7 billion in the second quarter or 5.1 percent of GDP.  Our domestic interest rates are, however, still remarkably low.

We believe that much of the current account deficit is due to unnecessarily slow foreign economic growth, which is impeding our exports.  To correct that situation, the Administration is aggressively encouraging pro-growth policies in other countries.  Secretary Snow and other top officials such as Commerce Secretary Evans and U.S. Trade Representative Zoellick have been traveling to Europe, China, Japan and other key areas to encourage reforms that will raise growth.  Progress has been made, with the G-7 countries agreeing to a new “Agenda for Growth” that incorporates accountability for performance as one of its features. 

Domestically, we see a need to increase our national saving, both through personal savings (which would be spurred by the Administration’s two proposed tax-free savings vehicles--retirement savings accounts and lifetime savings accounts), and through decreased Federal deficits (by constraints on spending).

Regarding China, we have encouraged the adoption of a flexible, market-based exchange rate.  While there has been a great deal of attention to exchange rates, we have a broad agenda with China including seeking a direct opening of product and services markets to U.S. companies in accordance with China’s commitments to the World Trade Organization.  China has made some progress in moving into compliance with WTO rules but there has been a loss of momentum, and complaints from U.S. exporters have arisen regarding intellectual property rights, trading rights and distribution services, transparency, and others.  China has agreed to move to an open market-based economy and to abide by WTO rules, but the pace of change has been very slow.  As complaints have mounted, Secretary Evans has urged the Chinese that they “must move faster by opening markets, dropping trade barriers, and letting market forces determine economic decisions.”  In an important recent development, Vice Premier Huang has accepted an invitation to come to the U.S. to engage in high-level talks with Secretary Snow.

Regarding Japan, the Administration has urged pro-growth reforms to bring about a lasting recovery.  These efforts appear to be bearing fruit.  The Bank of Japan has aggressively increased the money supply to counter deflation, and progress is being made in addressing problems in the banking system.  While further efforts at structural reforms would be beneficial, the Japanese economy is beginning to show signs of improvement.

Remaining Barriers to Growth:  Rising Health Care Costs

In addition to barriers to growth arising from imperfections in the flow of international trade, I would like to touch on another structural impediment to growth in the U.S.—rising health care costs.  After a period of relatively slow health spending growth in the late 1990s, growth has accelerated with the retreat of managed care.  Health spending now makes up over 14 percent of the economy.  The Bureau of Labor Statistics’ Employment Cost Index for health benefits has risen 10.1 percent over the past year, following an 11.2 percent increase the previous year.  Employers are struggling to control health care costs without reducing or dropping coverage, because private-sector efforts to improve value and efficiency are in their nascence and are not well developed.  Sustained health care cost increases are preventing firms from hiring new workers, while many workers may be reluctant to change jobs for fear of losing health insurance coverage. 

 In discussing the problem of rising health care costs, a distinction must be made between low-value care and high-value care.  Much of the growth in health expenditures stems from life-saving technological progress.  Mortality rates from cardiovascular disease, the number one cause of death in this country, have fallen by half over the past 40 years, much of that attributable to the technological revolution in health care.  Yet, in a Doctor Jekyll and Mr. Hyde sort of way, despite the technological progress, the health care sector is inefficient, as studies have indicated.
 Going back to cardiovascular care, bypass surgery is ten times more common in the U.S. than in Canada, yet health outcomes are very similar among patients with heart disease in both countries, according to one study.  Dartmouth researchers have found that there are wide geographic disparities in per capita Medicare expenditures, even after controlling for age, sex, and race of the relevant populations.  These differences cannot be explained by differences in the price of services or the health status of the relevant populations.  Study after study has shown that around 30 percent of health care expenditures are wasted: they do nothing to improve, and in some cases may even harm, health. 

The increasing strain of high and fast-growing health care costs is placing a growing burden on the federal budget.  Already, one-quarter of federal outlays are dedicated to health care expenses.  A mere one percentage point decrease in the anticipated rate of growth of health care spending would reduce the national debt by more than $600 billion over the next 10 years.  This is why the Administration is committed to rooting out the underlying causes of wasteful care to moderate the long-term growth rate of health care expenditures.

Conclusion

 Let me wrap up by reiterating a few points before I take questions.  The U.S. economy is on solid footing and the outlook going forward is bright.  The Administration will continue to strive to increase the rate of job growth and to reduce any inefficiencies and barriers that may inhibit the economy from maximizing its growth potential, including opening new markets abroad for U.S. exports and working to reduce growth in health care costs.