SYNOPSIS: Transcript of discussion. One of key instances when Krugman begins to believe more in New Economy productivity claims.

Paul Krugman and Stephen Roach, a chief economist and director of global economic analysis at Morgan Stanley Dean Witter, discuss the reasons behind the continued growth in the U.S. economy.

JIM LEHRER: President Clinton spoke at his news conference of the U.S. economy and its relationship to the rest of the world. It's that story we go to now with our economics correspondent, Paul Solman of WGBH-Boston.

PAUL SOLMAN: Today's job numbers underscore the continuing strength of the U.S. economy. Other positive signs include: An increase in new factory orders for the second month in a row, including a doubling in orders for airplanes; higher than expected retail sales; and an increase in orders for big-ticket items, so-called durable goods. Finally, the stock market has rebounded after a 20 percent decline last fall. In all, the United States is experiencing the longest sustained period of peacetime growth in its history. For eight years, the economy has continued to expand, and in the last quarter of 1998, the economy grew by 6.1 percent, the fastest pace in 15 years. Federal Reserve Chairman Alan Greenspan:

ALAN GREENSPAN: Can this favorable performance be sustained? In many respects, the fundamental underpinnings of the recent U.S. economic performance are strong.

PAUL SOLMAN: But Chairman Greenspan and other economists are carefully watching economic trouble spots around the world, which stand in sharp contrast to America's prosperity. In Japan, a key trading partner of the United States, the economy has been in the doldrums for a decade. Unemployment is now at a record high: Nearly three million jobless, the highest number since the Japanese Government began keeping count in 1953. Elsewhere in Asia, growth rates are projected to keep shrinking in Indonesia and Malaysia, countries still suffering from the so-called "Asian Flu," which first struck a year and a half ago.

In Brazil, economic woes forced the Government to devalue the currency, the real, in January. Since then, the value of the real has dropped more than 40 percent against the U.S. dollar, exacerbating the Brazilian recession. Meanwhile, the Russian currency, the ruble, has plummeted even more dramatically, losing better than 70 percent of its value since August. Russian inflation last year approached 85 percent, putting many goods out of the reach of ordinary Russians. And in Europe, the value of the new 11-nation currency, the much-touted euro, has dropped nearly 7 percent against the U.S. dollar since its launch in January. Plus, Germany, long an economic powerhouse, has seen its economy shrink in the last quarter of 1998. These and other crises have led to consistent warnings that the global economy could worsen and choke off the boom here in the United States. Fed Chairman Greenspan also has raised concerns.

ALAN GREENSPAN: We, nonetheless, are really quite dependent on what's going on in the rest of the world. And the slowing there does give us pause, so there is clearly a concern, and we are endeavoring to balance the international with the domestic, recognizing that we're evolving into a new type of international financial system in which we are, in a sense, learning as we're doing, and that is not the best way. There is no Economics 101 which carries us through what's going on today.

PAUL SOLMAN: How can the stock market be setting new records, the U.S. economy be doing so well while much of the rest of the world slumps? We pose that and other questions to two leading observers of the world economy. Paul Krugman is Professor of Economics at MIT -- his upcoming book "The Return of Depression Economics." Stephen Roach is Chief Economist and Director of Global Economic Analysis at the Wall Street firm Morgan Stanley Dean Witter. And welcome to you both.

PAUL SOLMAN: Paul Krugman, why is the U.S. economy doing so well, compared to the rest of the world?

PAUL KRUGMAN, MIT: I think the basic rule here is that, if you think that you understand everything that's been happening lately, you haven't been paying attention.

PAUL SOLMAN: Are you humbled?

PAUL KRUGMAN: I'm humbled. A lot of things I didn't think were possible are happening, some good, some bad.

PAUL SOLMAN: Not possible?

PAUL KRUGMAN: Things I thought were not possible, yes. I didn't think that the U.S. economy could have this low an unemployment rate without wages starting to pick up, and they're not picking up, which is incredible.

PAUL SOLMAN: Yes, all of the fantastic number of good news indicators and the only one that's not -- that is going nowhere basically is hourly wages.

PAUL KRUGMAN: That's right. And that of course in a perverse way is good news because it means that we don't have inflationary pressures coming from the labor front. But, on the other hand, if you asked me would it be possible that a country like Japan would be stuck in a recession that it didn't have a way to get out of, that it would be basically entering a kind of deflationary spiral and not be able to simply, you know, bootstrap itself out, I would have thought that was impossible also as little as a year ago.

PAUL SOLMAN: So this is an "I don't know" answer?

PAUL KRUGMAN: Well, you know, I have opinions. I have guesses, but no. It's a -- it's a world that's full of really bizarre things, like Chairman Greenspan said, we're learning on the job here, all of us, and you've got to have some humility.

PAUL SOLMAN: Stephen Roach, do you have any answer as to what's going on, or do you think you have an answer or one you're willing to give us?

STEPHEN ROACH, Morgan Stanley Dean Witter: Well, would I certainly concur with Paul Krugman. Humility is critical, especially these days on Wall Street. But I think it's really important to understand some key characteristics of the U.S. in this tumultuous global economy and that is, number one, we are not as connected through foreign trade flows to the rest of the world as you might think. Our foreign trade sector has grown a lot, but it's about 12 percent of our overall economy. And the portion of the United States that's more sensitive to interest rates is about double that. So as interest rates have come way down, in part reflecting the fact that in a period of fear and angst, as we saw last fall, foreigners want to buy Treasury bonds, the interest rate effects have overwhelmed the foreign trade effects, and that has really provided a powerful boost to the U.S. economy and a powerful boost to the U.S. stock market, which is very justified on the basis, again, of the interest rate underpinnings of the U.S. economy.

PAUL SOLMAN: So, you mean, in a perverse sort of way, we benefit from these problems abroad because everybody starts investing their money in the United States?

STEPHEN ROACH: We have a large U.S. economy, a diversified macro economic framework, and fortunately for us, we have a fair amount of built-in resilience into our macro structure. Another factor that's been a plus has been lower inflation, which expands the purchasing power of consumers and businesses alike. So America so far, and certainly, you know, we may end up revising this perception, but so far, we have not suffered nearly as much as most thought at the beginning of this Asian or global currency crisis.

PAUL SOLMAN: All right, so Paul Krugman, are we buffered? Do we, in fact, maybe even benefit from the, you know, people taking their money out of other countries and putting it here?

PAUL KRUGMAN: So far, yes. I mean so far, the crisis abroad means a strong dollar, which means cheap imports.

PAUL SOLMAN: Strong dollar because -

PAUL KRUGMAN: Because they're taking their money and putting it here instead of some place else.

PAUL SOLMAN: They're buying dollars

PAUL KRUGMAN: They're buying dollars. It means that, to the extent we compete with the rest of the world for supplies of oil and copper and tin and all of that, all those raw materials become cheap, which tends to keep our inflation down.

PAUL SOLMAN: So you mean, because they're all competing with each other, so the prices for that stuff is down?

PAUL KRUGMAN: Yes, and you know, countries like Japan aren't buying much of it because they're not producing a whole lot. The thing is that if there's one kind of rule that has tended to predict who gets in the biggest trouble next, it's the country that everybody thinks is immune. You know, I don't know if that's really fair, but I think you've got to, looking at this world, say sure, the U.S. economy looks great right now, but so did a lot of the economies that are now in deep trouble up till just months before the crisis hit. And if you don't have some anxiety, here again, I don't think you've been paying attention.

PAUL SOLMAN: This is the guy who's coming out with a book on depression economics.

STEPHEN ROACH: So Paul, you actually think the U.S. is about ready to follow Russia, Brazil, and Thailand?

PAUL KRUGMAN: No, but Japan looks to me disturbingly like us; that is, Japan is an advanced country with a stable government, and in some ways better than us because we're a big debtor nation, they're a big creditor nation. And I wouldn't have thought not very long ago that it was possible for Japan to experience the kind of crisis it's having. And if you talk to the Japanese now, they will tell you, "Oh, America 1999 is exactly like Japan 1989," that we're heading straight for the exact kind of bursting of the bubble they had. There's a kind of an embarrassing element of wishful thinking in their saying that, obviously. But if you were to ask, are we vulnerable? Probably. We've kind of forgotten that last fall, the U.S. bond market froze up there for a few weeks, and it was terrifying. I remember one Federal Reserve official in a meeting I was at describing the problem, people asked, "Well, what do we do about this?" And he said, "Pray," which is not what you want to hear from the Fed. In the end, Alan Greenspan got on his horse and rode out in front of the troops and waved his sword around and cut interest rates a little bit, but somehow or other restored morale in the markets, and it was heroically done, but it's not something you'd want to count on working every time.

PAUL SOLMAN: Stephen Roach, you see no danger? You don't think that there's a possibility?

STEPHEN ROACH: There's always a possibility.

PAUL SOLMAN: No, I mean - of course, there's some danger, but I mean substantial danger, such as Paul Krugman's suggesting, I guess -

STEPHEN ROACH: I would, with all due respect to Paul, take exception to the analogy with Japan. There's a very important difference, which he is well aware of, and that is that the U.S. economy is now into its second decade of restructuring driven by powerful market-based signals that it -- that really underscore the inherent flexibility of our system. Japan has done none of that. Japan is pretty much frozen at the switch in dealing with structural change, clinging to these outdated precepts of lifetime employment. The Japanese have basically the same unemployment rate as we do, and yet they've been in a recession for most of this decade. So you know, I certainly am very disturbed, like Paul is, about prospects in economic -- of the economy in Japan, but in no way do I think that the Japanese experience is a marker for what lies ahead in the United States.

PAUL SOLMAN: All right. But let's take the United States. What about the drop in exports, Mr. Roach? I mean you know, we've heard for years that exports is what's driving the vitality or much of the vitality in the American economy. Suddenly exports are dropping, our trade deficit is ballooning, fanning arguably the flames of protectionism. We just heard the President talking about this trade skirmish at any rate with Europe. You don't think that that's a potential cloud on the horizon?

STEPHEN ROACH: Oh, it sure is. I mean, we have a very large balance of payments of deficit, which clearly does make us the largest debtor in the world. There's always a chance that foreigners will get sick of helping us finance our external imbalance. And the dollar would fall and interest rates would rise in response. But look, here we are 20 months into the Asian crisis, and our economy over that period has grown at about a 4 percent clip even with a significant shortfall on the export side of the equation. And again, that goes back to the inherent resilience of the United States. We've got enough sources of growth where we can taken an export hit and by the way boost our imports to help the rest of the world and still grow at 4 percent. There aren't too many economies in the world that can pull that off.

PAUL SOLMAN: Yes. We actually grew by 6 percent in the last quarter, at least according to the latest numbers, --

STEPHEN ROACH: That's right.

PAUL SOLMAN: -- which is almost astonishing. Well, I mean do you think, Mr. Roach, that there's something about U.S., you know, it used to be called U.S. exceptionalism and then ten years ago when I audited courses, everybody would say there's convergence, everybody's converging on the U.S. experience. And now people say the U.S. is pulling ahead of the pack. What is it that's so special about us?

STEPHEN ROACH: Well, look, you know, this is not a time to beat your chest and become overly confident and complacent about the prowess of the U.S. economy. But here we are 20 months into the worst world financial crisis in 60 years, and our model seems to be working reasonably well.


STEPHEN ROACH: That does not mean that, you know, there are problems. And the reason it's working well is we have reasonably sound policy management, we have restructured our economy dramatically relative to where we were late 70's and early 80's. And we have broad and diverse sources of economic growth, whether it's from interest rates. income generation, job creation or even the wealth that's been created in our stock market. So we're firing on a lot of cylinders.

PAUL SOLMAN: So Paul Krugman, I mean, you're a guy who is as a theorist, actually talked about the possibility that, once you got something going that was good in economic growth you might be able to leverage that and grow even faster than other people, yes?

PAUL KRUGMAN: This is a world that's driven a lot by self-fulfilling prophecies. You know, you had a pretty good economy going along in Korea. Then, for whatever reason, people suddenly said, "Gee, I'm not so sure that economy's good." They pulled their money out and lo and behold you had an economy crisis in Korea that validated their complaints. And a lot of what keeps the U.S. economy going, a lot of what keeps other economies going -- if you're looking for a miracle economy in this crisis, it would be in Australia, which is - it's sort of in Asia. It should be a victim and yet they've grown 5 percent in the last year. Somehow or other they've managed to just ride this out. A lot of what keeps some economies immune is the fact that people think they're immune. Believing makes it so. And that's very good. And I think we have a lot of real virtue, and a lot of what Steve Roach is saying is true; that is, we are, in many respects, we're a more flexible economy, the Fed is a lot more flexible and intelligent than its counterparts in most other places in the world. But there's also a fair amount of luck. For whatever reason, world markets have concluded that we don't look like the Asians, that we are not part of that crisis, and as a result, we have been able to weather it because the main linkages between economies are not physical trade and goods; they are psychological. And we've been on the right end of that bargain so far.

PAUL SOLMAN: Steve Roach, last question: Can Italy, as we saw the President suggesting perhaps, actually emulate the United States economy? I mean do we have some model that if Italy only followed it, hey, they'd be doing as well as we were - Italy as a proxy for any country.

STEPHEN ROACH: We don't have a template that we sell to the rest of the world. We do have some characteristics with the way we have dealt with structural change, dealt with globalization, managed our policies reasonably effectively that can apply in some instances. And the Italians -- who would have "thunk" five years ago that Italy would have gone through such a dramatic reduction in its own inflation rate, in its own deficit to qualify for EMU, and yet they've done it. So they -

PAUL SOLMAN: You mean the European Monetary Unit.

STEPHEN ROACH: -- certainly have learned some important lessons. That's correct.

PAUL SOLMAN: EMU. They had these criteria. All right. Well, I think we have to leave it there. We could go on forever here, I think. Thank you very much, both of you.