Spend: a liberal economic program

SYNOPSIS: Krugman proposes a program to increase long-term economic growth

After eleven years in effect, the conservative economic program has failed. Most Americans are no better or even worse off than in the 1970s, and our long-term prospects are bleaker than ever. Supply-siders claim, of course, that their program was never really implemented, just as Marxists claim that the system that collapsed in Eastern Europe wasn't "true" socialism. In reality, however, Ronald Reagan got most of what he asked for, and delivered none of what he promised.

Now what? The following is a wish list of what a new economic program ought to include, regardless of its political feasibility. It's a liberal program in the narrow sense that it presumes that the government can do positive things not only for society but for the economy as well. It's also a conservative program in the non-political sense--that is, the sums of money involved are not large relative to the size of our problems. The irresponsible radicals who now call themselves conservatives will, of course, denounce my wish list as familiar tax-and-spend stuff. But taxing and spending is how the government does its job.

This is not, by the way, a cure for the recession, for which even George Bush is blameless. In this country recessions are almost entirely the responsibility of the Federal Reserve. Neither the recession that defeated Jimmy Carter nor the recession that just might defeat Bush was the president's fault. Conversely, of course, the recovery that allowed Reagan to claim it was "morning in America" had nothing to do with him either. We will eventually pull out of this recession, but the administration will have played little role in it.

The record we need to improve on is the longer trend: the dismaying performance of the U.S. economy from 1979, the year before Carter's recession, to 1989, the year before Bush's. My proposals are all aimed at doing what the conservative program did not: creating an environment to reverse this record in the long run and to share the benefits fairly all round.

At the core of my program is spending money in three major areas: child care, education, and infrastructure, all areas in which public spending is a form of investment in the future. Although political rhetoric for the past decade has extolled the virtues of private investment, the statistical evidence suggests that education and infrastructure are just as important in promoting economic growth. In international comparisons, education predicts economic growth better than private investment. Here at home the stagnation of American productivity after the early 1970s was not associated with any decline in private investment, which remained stable at about 18 percent of GNP; it was associated with declining SAT scores and sharply reduced public investment.

The biggest single problem that America faces is the state of its children. The statistics are familiar: 20 percent are in poverty; a much larger fraction pass through poverty at some point or grow up on the edge of it. At the same time there's good evidence that a variety of early intervention programs, ranging from prenatal care to Head Start, benefit not just their recipients but the public at large. It's crazy that we don't make such programs available to every child who needs them. Full funding of Head Start would cost some $6 billion; a broad range of child care programs could be funded for perhaps $10 billion to $15 billion. The eventual benefits, even in purely economic terms, would almost surely be large.

American children are among the worst educated in the industrial world. In international comparisons of math and science skills, they score at the bottom of the pack. Money alone will not solve the problem, but more money is needed. Teachers' salaries are far below those of occupations that require comparable skill, while increased equality between women and men has deprived the schools of a cheap pool of labor they could once exploit. The social troubles of our cities have greatly complicated the task of education. Financially strapped state and local governments are visibly savaging their educational systems. A real education president would provide substantial resources--say $20 billion--to help school districts in need provide for the basics.

The big-ticket item is infrastructure. From 1948 to 1969 the "core infrastructure" of the United States (roads, airports, water and sewage, etc.) grew at 3.7 percent per year. In the 1970s that figure fell to 2 percent; and from 1979 to 1987 it was 1.3 percent. Why do we need more roads and airports? Because our society is growing, and our metropolitan areas are being transformed by the growth of "edge cities": new subcenters of economic activity far from the traditional downtowns, generating whole new patterns of commuting and living. If we fail to support them with the necessary facilities, our economy becomes snarled in traffic jams--which are all the worse because we've slashed public investment so much that even our existing infrastructure is decaying. A reasonable price for such investment would be around $60 billion. While you're at it, throw in some support for our beleaguered high-technology industry, in the form of joint research projects, loan guarantees, and possibly some fancy infrastructure building (a national "data highway" is one possibility). Cost this at something like $5 billion to $10 billion.

Put all of this together and you have a spending program of perhaps as much as $100 billion annually, or a little more than 1.5 percent of GNP. Add such other desirable things as national health insurance and reducing the deficit, and an old-style liberal economic program could require resources equal to, say, 2.5 percent of GNP. Some of that can come from the peace dividend. For the rest, we need to turn to the unpleasant side of the program.

Two of the three unpleasant proposals for the U.S. economy will raise money for the government, although only one is primarily a revenue measure. The third will cost money in the short run but save much more in the long run.

For most Americans the lower taxes that were promised never materialized. Lower income taxes were offset by higher Social Security contributions and higher state and local taxes. For the very well-off, however, taxes have been cut dramatically since the late 1970s, while the share of income accruing to them has soared. These tax cuts in effect forfeited large sums of potential revenue. Estimates suggest that at 1977 tax rates the top 1 percent of the population would currently pay more than $80 billion in additional taxes--and still be better off than they were a decade ago. In general, restoring some progressivity to the tax system could yield $80 billion to $100 billion in revenues. Won't this redistributionist program destroy incentives? No. Its aim is not redistribution for its own sake, but the need for resources to meet real needs, resources that can best be provided by those who have benefited the most (indeed, have lately been the only ones to benefit) from the growth those resources can sustain.

At the same time, we can improve incentives while gaining revenue by charging realistic prices for the use of scarce common resources that are being handed out well below cost to small interest groups. The fee that loggers pay to utilize federally owned forests, for example, often fails to cover even the costs incurred by the Forest Service for making the trees accessible. Farmers in the desert pay a price for their publicly supplied water that is usually below the cost of supplying it and ignores the hidden burden imposed both on the environment and on water-short urban consumers (who pay a far higher price). Corporate jets with two or three passengers pay minimal charges to land at crowded airports, creating delays for commercial flights that carry hundreds. Our supposedly free market economy is riddled with such examples. It's puzzling that the Reagan-Bush administrations never made eliminating these distorted incentives a priority.

My final suggestion is a recapitalization of the banks. Bush's plan for bank reform didn't go nearly far enough. The basic problem of our financial system is not the lack of interstate banking; it is that bankers have an incentive to take bad risks, since it is heads they win, tails the FDIC loses. Until the 1980s this incentive did not cause too many problems because--thanks to government restrictions on competition--banking was such a profitable business that few bankers were tempted to gamble with their lucrative franchises. Nowadays, however, many banks have only paper-thin capital--that is, the value of their deposits and other debt is nearly as large as, or in some cases larger than, the value of their assets. This makes the incentive to gamble irresistible--indeed, banks that do not take undue risks cannot compete with those that do.

The only way to solve this problem is to require the owners of banks to put much more of their own money at stake--to raise capital requirements to levels far above what anyone is willing to talk about. Banks hate this idea; worse still, some banks will be unable to raise the capital and will have to be seized and recapitalized with public funds. Yet if we don't do this, the S&L mess will turn out to be only the first reel in an ongoing disaster film.

What will all of this accomplish? My wish list would do little to raise the U.S. growth rate over the next four or even eight years. Programs for children will not pay off economically until their targets enter the labor force; and investment in infrastructure, getting the prices of scarce resources right, and even eliminating the bad incentives in our financial system will take years to yield major fruits. The eventual payoffs, however, will be large. Two decades of short-termism in government (for Reagan did not begin the process) have damaged our economy but also created opportunities. Think of the U.S. economy as a "handyman special"--a house that has been neglected and looks awful, but that with a moderate amount of repair work can be radically improved. Nobody knows how to guarantee an economic miracle, but sometimes a new furnace and a fresh coat of paint can work wonders.

Originally published, 12.23.91